Algorithmic trading has been around for some time in the financial markets.
For those of you who are not familiar with the term algorithmic trading, it is the process of using computers to help identify and execute trading opportunities based on a trading strategy that a human trader has programmed it to.
Why Do People Use Algorithmic Trading?
The whole idea of trading is to generate profits through the trading of financial instruments. Traders can hold on to positions from anywhere between a few seconds to weeks. The longer a trader holds to a position, the higher the risk that the position they hold may be affected by unexpected events or news.
To avoid holding on to positions for long periods of time, some traders would trade at a high frequency. A high frequency trader may enter and exit from multiple trades in a single day.
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Most good traders will have a fixed strategy (or two) that they use for their trades. These strategies include entry and exit signals and the use of relevant indicators to help them make sound decisions.
Algorithmic trading allows the traders to program their trading strategies for entering and exiting a trade into a computer software. The software will then automatically alert traders whenever trading opportunities that fit into the criteria arises. The trade is made and profits can be taken when it hits a pre-set level. On the downside, losses will also be made when the stop-loss for the trade is triggered.
Advantages of Algorithmic Trading
# 1 Backtesting
Backtesting refers to the process of testing a trading strategy based on historical data in order to ensure that a trading strategy actually works in the financial market.
Algorithmic trading uses backtesting a lot. Traders’ backtest their strategies to find out if it work before introducing it into their trades. No trading strategy is perfect, but some are simply better than others, thus giving traders a higher probability of success. Backtesting helps identify good strategies to a certain extent.
# 2 Remove Emotions From Trading
When traders have a winning strategy that allows them to be successful in their trades, the next thing they need to do is to execute their trades as per their plan. That’s where algorithmic trading can play a big role in the success of the strategy. As the saying goes, computers don’t have any feeling. They simply follow the instructions given to them by their human creators, or in this case, traders.
Algorithmic trading focuses solely on the execution of the strategy that the trader has set in place. The strategy does not deviate. If it’s good, success should show. If it’s not, losses would be made. Human errors or emotions should not play a part in the outcome.
# 3 Review And Refine Trading Strategies
As mentioned above, no trading strategy is perfect. Even a great trading strategy may not withstand the test of time when market conditions change against it. That’s the reason why it’s important for traders to review and refine their strategies periodically, even when it’s working well.
With algorithmic trading, traders can review the performance of their previous trades, how they have panned out and ways they can improve on their strategies. They may also notice seemingly innocuous trends, such as how their trades, for some reason, perform better during certain time of the day, or with certain currency pairs.
This can help them optimise on their trade decisions so that they choose what works best for their trading strategy.
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Using MetaTrader 4
MetaTrader 4 (MT4) is a trading platform that is widely used by many traders around the world. Released in 2005, the availability of MT4 sparked a wave among retail traders who could now use algorithms for their trades; an option that was previously only opened to financial institutions and big hedge funds.
MT4 provides the functions that you would need to become an algorithm-based trader. These include features such as expert advisors and custom indicators that can be easily installed to alert you, or even automate your trading.
For traders who want to explore trading with MT4, you can create an online account with IG in just a few minutes. Once you log in to your account, simply choose to open a CFD trading MT4 Account. Alternatively, you can also open a demo account first if you just want to start practising first in a risk-free environment.
If you wish to learn more about algorithmic trading, IG has a series of free seminars line up for you to attend this month. However, always remember to get familiar with the instruments you trade, and to ensure that you understand the risks you are facing before you start trading.
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This article was sponsored by IG, the world’s No.1 CFD provider (by revenue excluding FX, 2015). All views expressed in the article are the independent opinion of DollarsAndSense.sg