This guide will help you design an algorithmic trading strategy to control your emotions while letting the machine do the trading for you. Why would you want to use a high-frequency algorithmic trading strategy? What type of algorithmic bot is best? They are all revealed in this algorithmic trading strategy guide. At the end of this guide, you will learn the secret ingredients needed to develop a profitable Forex Algorithmic Trading Strategy.
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Algorithmic trading has become more popular over the past decade as electronic trading advances. Algo trading first started in the 1980s. Today, it accounts for nearly 70% of all trading activity in developed markets.
To improve your knowledge of quantitative trading, I recommend reading Ernest P. Chan’s Algorithmic Trading Winning Strategies and Their Rationale. Ernest has written one of the best algorithmic trading strategy books. What sets this insightful book apart from others is that it focuses on examples of algorithmic trading strategies rather than just theory.
Let’s answer some of the most common questions.
- What is a forex algorithm trading strategy?
- How do they work?
- Who should trade Forex Algorithm Strategies?
- And when should you use a forex algorithmic trading strategy?
Let’s begin.
What is Algorithmic Trading?
Algorithmic trading is a technology that uses computer programs to automate the process of buying and selling stocks, options, futures, FX currency pairs, and cryptocurrencies.
On Wall Street, algorithmic trading is also known as algorithmic trading, high-frequency trading, automated trading, or black box trading. These terms are often used interchangeably.
If you want to know how high-frequency trading works, check out our guide: How High-Frequency Trading Works – The ABCs.
Essentially, an algorithm is code that follows a set of automatically executed step-by-step operations. Step-by-step actions are based on the inputs you program. Input variables can be things like price, volume, time, economic data, and indicator figures. Any kind of variance of these input variables can be used.
When these criteria are met, a buy or sell order is executed.
Next, learn how trading algorithms work. You will also learn what you need to do to conduct trades in a fully automated way.
How does algorithmic trading work?
Algorithmic trading works according to a three-step process.
- I have a trade idea.
- Turn your trading idea into a trading strategy.
- The trading strategy is converted through an algorithm.
Once an algorithmic trading program is written, the next step is backtesting. Backtesting uses historical price data to determine viability. If your algorithm provides good backtest results, consider yourself lucky to have an edge in the market. Finding an edge in the market and coding it into a profitable algorithmic trading strategy is not an easy task.
Learn how to backtest your trading strategy using Backtesting Trading Strategy.
The first (and most important) step in algorithmic trading is to get proven profitable trading ideas. Before learning how to create a trading algorithm, you must have an idea and strategy.
Having an edge in the market takes competence and skill. The best algorithmic traders have competency and proficiency in three areas:
- Trading and financial market knowledge.
- Quantitative analysis or modeling.
- Programming skills.
What are the best programming languages used for algorithmic trading?
Python Algorithmic Trading is probably the most used programming language for algorithmic trading. Matlab, JAVA, C++ and Perl are other algorithmic trading languages used to develop excellent black box trading strategies.
Currently, the best coding language for developing forex algorithm trading strategies is MetaQuotes Language 4 (MQL4).
Let’s recap what it takes to develop an algorithmic trading strategy. PDF:
- Trading strategies based on quantitative analysis.
- Choose the right algorithmic trading software that will connect you to an exchange and automatically place your trades.
- Live data for trading.
- Historical price data for Algo backtest.
- IT infrastructure for high frequency trading. For example, powerful computers that handle advanced mathematical models, servers, backup performance, and fast internet connections.)
- Co-location feature for setting up servers at stock exchange locations (e.g. NYSE if you trade stocks). This helps minimize trade execution and gives you an advantage over your competitors. Co-locations are often used for high-frequency trading.
Now let’s see who the market participants are. Who is the biggest user of algorithmic trading in the trading environment?
Who uses algorithmic trading?
In essence, experienced traders with coding skills can use programmed trading strategies to trade on their behalf. Individual traders can code their own algorithmic trading robots to do more than just open buy and sell orders. Algorithms can be used for much more complicated things like:
- Generate complex mathematical calculations.
- Predict market movements.
- Generate trading signals.
- Crisis management
- Others.
The most adept algorithmic traders are big institutions and smart money. Hedge funds, investment banks, pension funds, prop traders and broker dealers use algorithms in market making. These people are tech savvy and make up the best algorithmic trading in the world.
Note: Market making today is done through machine learning. You can learn more about this topic by reading Strategies for Making Intelligent Markets in Algorithmic Trading PDF.
We will look at the types of algorithmic trading strategies going forward.
See below:
Introduction to Algorithmic Trading Strategies
Some algorithmic trading strategies are used to generate profits. Others are used to create orders. Throughout this algorithmic trading guide, we will focus on profit-seeking algorithms. We are not interested in algorithmic order management or order filling algorithms.
The order filling algorithm executes a number of stock shares or futures contracts over a period of time. The order filling algorithm is programmed by breaking large orders into smaller pieces. You cannot shift the position of the market in this way.
The most popular algorithmic sequences and techniques used by smart money are:
- Iceberg
- Time slice
- VWAP
- TWAP
- PEG/BBBO
The herd mentality is to follow the big bucks. If you understand how large orders can affect the market, if the entire street knows your intentions, you will ultimately not get the price you want.
If you want to buy ABC stock, try to buy it the full distance and the stock price will be artificially high. This is a classic example of supply and demand.
Next, we’ll take a quick look at the best algorithmic strategies. What are the most commonly used trading strategies in Algo trading? Read on.
What are the best algorithmic trading strategies
We have a variety of algorithmic trading strategy examples. We will give you an extensive list so you can see the big trends.
Broadly speaking, most high-frequency algorithmic trading strategies fit into one of the highlighted categories.
- Momentum strategy
- Average return strategy
- Emotion based strategy
- Statistical Arbitrage Strategy
- Market-making strategies
The winning algorithm trading book of strategies and their rationale will teach you how to implement and test these concepts into your own systematic trading strategy.
Algorithmic Trading Momentum Strategy
When volatility or momentum ignition spikes, momentum-based algos simply follow. Thinking jumps on that momentum spike by placing a buy or sell order and a tight stop. The idea behind momentum-based algorithms is simple. When the ball starts rolling, it continues until it finds resistance.
Indicators and price statistics can be used to determine market momentum.
S & One very simple automatic trading algorithm used for P 500 E-mini futures is Emini S & It is programmed to supply buy orders when the P 500 creates a new intraday after the open.
Day Trading Emini Futures by a Veteran Trader of 35 Years: Discover the Secrets and Techniques Developed by Day Trading Strategies Emini Futures.
Mean Reversion Algorithmic Strategy
Mean regression systems are another type of algorithmic systems that operate under the premise that the market is up to 80% of the time. The price usually pulls in the average price.
Algorithmic traders use historical price data to determine the average price of a security. You then place a buy or sell order in anticipation of a return of the current price to the average price.
Algorithmic Trading Sentiment Strategy
Sentiment-based algorithms are news-based algorithmic trading systems that generate buy and sell trade signals based on how real data is revealed. The algorithm can also read general retail market sentiment by analyzing the Twitter data set. The goal of this algorithm is to predict future price movements based on the behavior of other traders.
You should have a good understanding of how financial markets work and a powerful technique to develop sentiment trading algorithms.
Marketing Algorithm Trading Strategy
Market makers, also known as liquidity providers, are broker-dealers who create markets for individual instruments. This can be stocks, bonds, commodities, currencies and cryptocurrencies. The main task of market decision algorithms is to provide buy and sell price quotes to the market. Marketing production algorithms can also be used to match buy and sell orders.
One of the most widely used market decision algorithms involves the simultaneous placement of buy and sell orders. These types of market decision algorithms are designed to capture spreads.
Statistical Arbitrage Algorithm Trading Strategy
Most statistical arbitrage algorithms are designed to exploit statistical miscalculations or price inefficiencies in one or more assets. Statistical Arbitrage Strategies, also known as Statistical Statistical Strategies, are a subset of mean reversion strategies.
Stat arb involves complex quantitative models and requires large computational power.
The most popular form of statistical arbitrage algorithmic strategy is the pair trading strategy. Pair trading is a strategy used to trade the difference between two markets or assets. Pair trading involves essentially taking a long position in one asset and simultaneously taking an equal-size short position in another asset.
Check out what our favorite arbitrage trading bots are. Before reading How to Make Money in Arbitrage Software.
Forex Algorithmic Trading Strategies
FX algorithmic trading strategies help reduce the human error and emotional pressure that comes along with trading. The goal is to build a smart algorithm that can compete and beat other high-frequency trading algorithms.
Most traders don’t have the money to pay for powerful computers and expensive placement servers. Competing against other HFT trading algorithms is like competing against Usain Bolt.
So how can you compete with other quants?
What’s the secret to winning this race?
As Sun Tzu said in The Art of War: “Keep your friends close and your enemies closer.”
The best way to follow this principle is to analyze the behavior and behavior of different Forex algorithms.
For example, a dirty secret and standard practice that many algos use is the momentum ignition strategy. This algo causes the price to skyrocket above a certain key level. Typically, these algorithms incorporate support and resistance, swing high/low pivot points, or other key technical indicators. This action will encourage other traders to trade behind the move.
The forex chart below shows the actual forex momentum ignition algorithm:
Forex algorithms can be trained and programmed to respond to these types of actions. If you have good programming skills, you can build a system of Forex algorithms to sniff out when other algorithms are driving momentum ignition.
Final Words – Algorithmic Trading Strategy
Developing an algorithmic trading strategy takes time, but the merits and peace of mind are worth it. This is a very competitive space that requires excellent knowledge and programming skills to develop high-frequency trading algorithms.
Cyber warfare is raging in the financial markets with the rise of high-frequency trading robots. Forex Algorithmic Trading Strategies have also brought to life several other trading opportunities available to traders.
Thanks for reading!
