Forex is the largest, and most liquid, market in the world. With roughly $4 trillion changing hands every day, it represents an incredible powerhouse for you to take advantage of. Speculators, called forex traders, enter this market with one purpose: to scalp profits from the market. Every day, currencies change in relative value to one another. The forex market is where traders come to trade on the difference between these values.
Currencies are always traded in pairs. Because of this, there is always a “winning” currency and a “losing” currency. In other words, as one currency rises, the other must fall. Forex markets move incredibly fast, so it’s entirely likely that you’ll have to become familiar with algorithmic trading if you want to make any money.
Fundamental Analysis vs Technical Analysis
There are two basic methods of analyzing the currency markets: fundamental analysis and technical analysis. Fundamental analysis involves analyzing political and economic news as well as other qualitative factors. While there may be some quantitative calculations, the focus is not on data mining.
Technical analysis assumes that all relevant information is already contained in the price of the currencies. Therefore, technical analysts only concern themselves with historical data. They use this data to draw conclusions about future market performance. Technical analysts also tend to use charting software, which can be extremely helpful in making trading decisions.
Technical analysts often rely on charts to make investment decisions. These charts track historical data and when enough data has been gathered, analysts can then start to look for trends. For example, an uptrend (a rising market) might be seen in the morning for a particular currency, while a downtrend is noticed for the same currency later on during the day.
If a trend is spotted, traders can take advantage of it by buying or selling currency appropriately. Of course, doing all of this by hand makes the job pretty tough.
An algorithm is a mathematical formula. As long as the formula is valid, and the assumptions input into the formula are valid, then the algorithm will always work. This is why algorithmic trading has become so popular. It can become a “set and forget” trading style.
This type of trading software takes over the manual process of looking at technical data. An algorithm is set up, and trades are automatically executed based on specific criteria set by the trader. Trends can be taken into account, and buy and sell limits can be established.
The major flaw in algorithmic trading becomes apparent when the entry of the formula aren’t valid. For example, a trend may unexpectedly reverse, or a trader may not foresee certain fundamental indicators that could have a significant impact on the market. Since the algorithm doesn’t think for itself, it won’t know how to adjust any positions in such circumstances. It can only do what it’s programmed to do. This is why many technical traders will often supplement algorithmic trading with good fundamental analysis. Still, as an amateur trader, using software to do the heavy lifting for you takes most of the burden off your shoulders and allows computers to do what they do best – math – and that will always be an important part of forex trading.
Guest post contributed by Stacy Pruitt, a freelance forex and finance strategy writer. Stacy loves to keep up with the latest trend in forex indicators. She often writes on the results she achieves with online forex trading.