How does automated Forex trading work?
Technology have surely helped forex traders that can turn exact entry, exit and money management rules into automated Forex trading system. With the help of computers are therefore able to perform and monitor trades reducing the risk of emotions and human errors in forex transactions.
Since trades are automatically placed when qualifying criteria are meet, there is little room for negative and destructive emotions that are one of the major responsible for unsuccessful trades.
In a nutshell the trading software or Forex robot will execute all the trades you have pre-set: it will open and close trades while you are doing something else or relax. But the main question is: how effective is automated Forex trading? In this article we will answer some of the most recurrent questions so you can get a clear view of what automated Forex trading can do for you.
What is an automated trading system?
An Automated trading systems also known as automated FX trading, allow traders to set up some particular criteria for entering and exiting trades. Those will then be carried out by a computer.
Entry and exit rules can be set up based on single conditions like for example a Moving Average crossover or can be a lot more complex: to set up the latter a very good understanding of the programming language is needed.
In order to work the automated trading system will need to be connected to a direct access broker. The most popular trading platforms are MetaTrader 4 and MetaTrader 5 that are both using MQL programming language. Some automated Forex trading platforms have simplified lots of things by offering strategy building ‘wizards’ that will allow traders to make some decision on commonly accessible technical indicators. This allows traders to set up quite easily a set of rules that will then guide the computer during the trade.
For example the trader could set up a long trade that will be entered as soon as the 50-day MA crosses above the 200-day MA on the 5 minute chart of a specific financial asset. Users will also be able to input the type of order (which could be market or limit) and also set up when the trade will be triggered. Most traders however like to build up their own strategies and customer indicators: they normally work closely with a programmer that will design their FX automated trading system.
Surely this route requires a lot more effort than using the wizard but it will allow later on much more flexibility and could payoff a lot more than using standard trading strategies. So once the rules will have been set up the computer will monitor the markets to find a good opportunity to buy or sell depending on the trading strategy: when this appear it will carry out the auto Forex trade.
Once a trade is entered it will then use other rules to set up a protective stop-losses, trailing stops and also profit targets.
The pros of automated trading and automated systems
Surely automatic Forex trading has lots of advantage over the traditional-manual trading. The main one is that, as we have mentioned above, the automating trading will basically eliminate the impact of emotions in the trading. Emotions are the first responsible in diverting trading plans and by eliminating those the traders will stick to their plans much easily. Trade orders will automatically executed following the strategy that has been set and the traders will not have the chance to question the trade or the strategy.
Another important advantage of trading with the help of a computer is that the forex trader will not have the opportunity to over-trade: overtrading is when a trader will buy or sell at every perceived opportunity even if it is not meeting the overall strategy.
Another good advantage of using automated trading is the ability of backtest. Backtesting is the process of applying trading rules to historical market data to define how successful an idea is. When you are developing a strategy for Forex automated trading, all rules will need to be as precise as possible and this will allow you to see what would have happened if you started to use them in the past.
This is particularly important as Forex traders will be able to test the rules against historical data and in doing so preventing that money will be risked in live trading. By running backtesting a trader can evaluate and fine tune a trading idea and also see what is the expected return based on actual historical trading data. It will give a very good indication of how much you can win (or lose) by deploying your strategy.
Forex auto trading will also preserve discipline. Rules are set and trade execution will be carried out automatically and immediately so even in very volatile markets you can be sured that discipline will be preserved. Especially for beginners traders the discipline is normally lost due to emotional factors: a trader might not be accepting to take a loss or he might want to try to squeeze a bit more profit from a trade. This can result in substantial losses and automated trading will help to ensure discipline is retained as he will follow the trading plan precisely. Also it will avoid manual errors: an error to purchase 100 lots will not be incorrectly set up as an order to sell 1,000 lots etc.
So with automatic trading you will achieve consistency which is very important. The main challenge in Forex trading is planning the trade and than follow the strategy. It is important to accept that having a trading plan that will win 100% of the time is not possible and that losses are to be considered a part of the game. Losses however can have a bad effect on the psychology of the trader: for example if a Forex trader loses 2 or 3 trades he might decide to avoid the next trade. Considering that the next trader might have been a winner, the trader in doing so has ruined any expectancy the system had. By using Forex auto trading this will not happen as the auto trade will not be affected and will therefore achieve consistency.
Order entry speed is another big advantage of using auto trader. Computers will respond immediately the changing markets conditions even in very volatile markers. This means that traders will have the opportunity to get in or out from trades in few seconds and this can have a great difference in the trading results. Some markets tend to move very fast and it is a very bad experience to see that you are missing a profit just because you are been too slow in entering or exiting a trade.
The last advantage of auto trading is that you can diversify trading. With automated Forex trading you will be able to trade multiple accounts or try different strategies simultaneously. Over time this will spread the risk over a number of financial assets and also generate a hedge against losing positions. Also the software is capable of scanning for trading opportunities across a huge range of markets, create new orders and monitor existing trades.
The cons of automated trading and automated systems
We have seen that automated trading has lots of advantages. But it has also some disadvantages that it is important to analyse.
Mechanical failures can happen in softwares and even the automated trading is not infallible. Depending on the trading platform you are using the trade order could actually be hosted in a computer and not in a server. This means that if you lose the internet connection than the order might not reach the market. Also, there might be some errors in setting up the strategy and the rules. Before getting the best results with automatic trading you need to expect a learning curve and starting to trade with small amounts is surely a good idea.
It is important to monitor the automatic trading system. The idea of turning the computer on and leave for the day is surely an attractive one but due to the potential for mechanical failures like the connectivity issue we have seen (or computer crashes, power losses, etc) it is important to monitor that everything is running smoothly. We have seen that sometimes the auto trade Forex system could have some anomalies that might well result in missing orders, errant orders or even duplicate orders. If the system is consistently monitored those problems will be found immediately and can be resolved swiftly.
Another drawback is over-optimisation. Sometimes Forex traders who employ backtesting techniques look great on paper but will be terrible when in a live market. This is because of over-optimisation which is the excessive curve-fitting that generates a trading plan that is completely unreliable in live trading. The main issue behind this is that trades sometimes believe that it is possible to have a plan that is close to 100% profitable trades. They also have the impression that a plan should never have drawbacks. By thinking in this terms they continuously adjust the strategy to create a ‘near ideal’ plan but they then usually fail once it is applied to a live market as the system is over-optimised.
We hope that you now have a much better understanding of what is automated Forex trading and what are the pros and cons of this innovative way of trading. Our opinion is that despite those systems are appealing for a number of reasons they shouldn’t be considered a substitute for carefully executed trading. As we have mentioned mechanical failures do occur and the system will require a continuous monitoring. Server-based platforms will reduce however the risks of mechanical failures. We therefore suggest to use the hybrid of manual and automated FX trading to get to the best trading results.