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How does automated Forex trading work?

Reading time: 9 minutes

How automated Forex trading works

Forex traders and investors can turn exact entry, exit and money management rules into automated Forex trading systems that enable computers to perform and monitor trades. One of the biggest attractions of strategy automation is that it can eliminate any negative and destructive emotions in trading, since trades are automatically placed as soon as certain criteria are met.

In other words, your chosen trading software or Forex robot executes all trading processes and opens and closes trades, whilst you sit back and relax. But is automated trading effective, and if it is, how to do automated Forex trading? In this article we will answer some of our most frequently asked questions rationally, so you can gain a true understanding of automated Forex trading.

What is an automated trading system?

Automated trading systems, or automated FX trading, allows traders to set particular rules for both trade entries and exits that can be automatically carried out by a computer. Trade entry and exit rules can be based on simple conditions, like a Moving Average crossover, or can be based on sophisticated strategies that demand a comprehensive understanding of the programming language specific to the user's Forex trading platform.

Typically, automated trading systems require the application of software that is linked to a direct access broker, and any particular rules need to be written in that platform's proprietary language. For instance, the most popular trading platforms MetaTrader 4 and MetaTrader 5 use MQL programming language, whilst the NinjaTrader platform uses the NinjaScript programming language.

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Some automated Forex trading platforms have strategy building 'wizards' that permit traders to make choices from a list of commonly accessible technical indicators to build a set of rules that might then be automatically traded. For example, the trader could establish that a long trade will be entered as soon as the 50-day MA crosses above the 200-day MA on a 5-minute chart of a specific trading instrument. Users can also input the type of order (e.g market or limit) and precisely when the trade will be triggered (e.g at the open of the next bar or the close of the bar), or exploit the platform's default inputs. However, a lot of traders decide to program their own strategies and custom indicators, or work closely with a programmer to design their FX automated trading system. Whilst this often requires more effort than using the platform's wizard, it permits a much greater degree of flexibility and the results can be considerably more rewarding.

As soon as the rules have been set, the computer can monitor the markets in order to find buy or sell opportunities based on the trading strategy, and carry out auto Forex trading. Once a trade is entered - depending on the specified rules - orders for protective stop-losses, trailing stops and also profit targets will be entered. Moreover, in fast moving markets this immediate order entry can mean the distinction between a small loss and a disastrous loss in the event that a trade moves against the trader.

The pros of automated trading and automated systems

Let's look at some of the advantages of automatic Forex trading. The first one has been mentioned above - automated trading minimises the impact of emotions in the trading process. By keeping emotions at bay, traders generally have an easier time sticking to their primary plan. As trade orders are automatically executed as soon as the trade rules have been met, Forex traders will not have the chance to hesitate or question the trade. Additionally automated trading can prevent overtrading - i.e. purchasing and selling at every perceived opportunity.

The next advantage is the ability to backtest. Backtesting applies trading rules to historical market data to define the viability of the idea. When developing a system for Forex automated trading, all rules have to be absolute with no space for interpretation - i.e a computer must do precisely what needs to be done without guessing.

In addition, Forex traders can use these rules and test them on historical data prior to risking money in live trading. Careful backtesting permits traders to evaluate and fine-tune a trading idea and also to identify the system's expectancy - the average amount that an FX trader can anticipate to win (or even lose) per unit of risk.

Forex auto trading also preserves discipline. As trade rules are set and trade execution is carried out automatically, discipline is preserved even in volatile markets. Discipline is frequently lost due to emotional factors like fear of taking a loss, or the desire to gain a little more profit from a trade. Automated trading helps to make sure that discipline is retained, because the trading plan will be followed precisely. Additionally, pilot-error is diminished, and an order to purchase 100 lots will not be incorrectly entered as an order to sell 1,000 lots accordingly.

It would be a mistake not to mention that automated trading helps to achieve consistency. One of the biggest challenges in Forex trading is to plan the trade and then trade the plan. Even if a trading plan has the potential to be profitable enough, traders who ignore the rules alter any expectancy the system would have actually had.

You should understand that there is no such thing as a trading plan that wins 100% of the time - losses are always a part of the game. However, losses can be psychologically harmful, so a Forex trader who has two or three losing trades in a row may decide to skip the next trade. This next trade could have been a winner, so the trader has already ruined any expectancy the system had. Thus, Forex auto trade systems enable traders to achieve consistency.

Another benefit is improved order entry speed. As computers respond instantaneously to changing market conditions, automated systems are capable of generating orders once trade criteria are met. As a consequence, getting in or out of a trade a few seconds earlier can make a big difference in the trade's outcome. Once a position is entered, all other orders are automatically created, including protective stop-losses and also profit targets. You know that markets can move quickly and it is demoralising to have a trade reach the profit target or blow past a stop-loss level prior to the orders being entered.

Finally, the last advantage is that you can diversify trading. An automated Forex trading platform allows the user to trade multiple accounts or different strategies simultaneously. In turn, this has the potential to spread risk over various instruments while generating a hedge against losing positions. The software is able to scan for trading opportunities across a range of markets, create orders and also monitor trades.

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The cons of automated trading and automated systems

Despite the advantages, you should know that automated trading is not deprived of certain disadvantages.

Software is software and mechanical failures occur from time to time. The theory behind auto trading Forex makes it seem rather simple: setup the software, program the rules and watch it trade. However, the reality does not always reflect the anticipation. Automated trading is not infallible. Depending on the trading platform, a trade order could actually reside on a computer and not a server. This implies that if your internet connection is lost, then an order might not be sent to the market. There could also be a discrepancy between the so called hypothetical trades generated by the strategy and the order entry platform component that turns them into real trades. The majority of traders should expect a learning curve while using automated currency trading systems and it is a good idea to start with small trade sizes while the process is refined.

The second con is monitoring. Though it would be magnificent to turn the computer on and leave for the day, automated trading systems require monitoring. This is due to the potential for mechanical failures, such as connectivity issues, computer crashes or power losses and system quirks. It is possible for an auto trade Forex system to experience anomalies that could result in missing orders, errant orders or even duplicate orders. If the system is monitored, those events can be determined and resolved swiftly.

And the last most apparent drawback is over-optimisation. Although not specific to auto currency trading systems, Forex traders who employ backtesting techniques can produce systems that look great on paper and do terribly in a live market. Thereby, over-optimisation refers to excessive curve-fitting that generates a trading plan that is unreliable in live trading. For instance, it is possible to tweak a strategy to reach exceptional results on the historical data on which it was tested. Trades occasionally incorrectly presume that a trading plan should have close to 100% profitable trades or should never experience a drawdown to be a feasible plan. As such, established parameters can be adjusted to create a 'near ideal' plan, however these will usually fail once it is applied to a live market.

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Following this article, we hope you can now answer the question - what is automated Forex trading? Though automated trading may seem appealing for a variety of reasons, such systems should not be considered a substitute for carefully executed trading. Mechanical failures can and do occur - and systems require monitoring. Server-based platforms might provide a solution for traders wishing to diminish the risks of mechanical failures. We suggest you to use the hybrid of manual and auto FX trading to achieve the best results.

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