So… you know the fundamentals of Forex and have all your ducks in a row, but have one more question before you can fully take the plunge.
What method do you want to use to trade?
When it comes to Forex there are two main methods to trade by:
- Algorithmic trading
- Manual trading
Manual trading is a forex trading method that uses human interaction to execute trades. This is done typically by yourself at your discretion. Manual traders rely on more than themselves though, oftentimes there is still technology involved.
Some believe that this may be the superior method because human judgement may be perceived as better than a bot.
Manual Trading Methods
Manual trading methods follow three different styles. There is the buy-and-hold, swing trading and day trading.
Buy-and-hold is when an investment is purchased and it is assumed it will appreciate in value, so the buyer holds until they deem it the perfect time to sell…buy low and sell high.
Swing trading involves trades that only last a few days or a few months. This is a short term trading method. The goal here is to find an opportunity and hold onto it for the bulk of its gains and then jump to the next opportunity and make gains there as well.
Day trading aims at trying to make gains from intraday price movements. This would mean having to make multiple purchases and transactions throughout the day.
What is Algorithmic Trading?
Algorithmic trading is the method that uses a bot or algorithm to make all decisions and trades on the account. This means all the mental load of making the choices are lifted from your shoulders.
Those that favor algorithmic trading feel that bots keep a level head in trading because there is no human emotion attached to the trades.
In algorithmic trading, specific rules are still programmed, but once set, bots simply follow their commands. Automated systems typically involve purchasing a software that is linked with a direct access broker.
Algorithmic Trading Strategies
Some algorithmic systems follow a mean reversion technique. This means that there is an assumption that markets are ranging 80% of the time. This is done by figuring out the average asset price by interpreting and analyzing historical data of the market.
Algorithms can also follow market sentiment. This is done by looking at non-commercial and commercial positionings to determine market tops and bottoms. Recent developments in this strategy also allow for scanning of social media to determine and analyze currency biases.
Arbitrage is another technique that falls under algorithmic strategies. With this strategy, the bots are programmed to be able to find imbalances across the markets and be able to get profits from those. Granted when these types of moves are programmed, this requires very large moves because changes often occur in micro pips.
Stealth follows close to the next example (iceberging). This style algorithm aims at piecing together small moves that are assumed to be done by large players trying to spread out their bid. This method takes a great deal of knowledge in quantitative analytics as well as java programming to be able to fully execute.
One last example of an algorithmic trading strategy is iceberging. Iceberging is used by large companies that withhold their overall strategies and moves. This method means trading through multiple brokers rather than just one. Trades are run over smaller positions at different time slots and in turn it makes it so other traders can fully see what trade is executed. This allows these users to be able to trade under normal conditions and better avoid fluctuations.
Who is Manual Trading Best Suited For?
Manual trading is best suited for those that consider themselves top notch in the field. These are the people that have the TIME to be able to invest in the trade beyond the funds. A manual trader also needs the time to observe and learn the global markets.
Another aspect is having the knowledge on how trading works. This can be another time aspect, but it is more so experience based. This trader needs to know how trading works, different types of trades and purchases, and how the market works and performs.
Aside from time and knowledge, manually trading is also best suited for traders that want complete control over their portfolio. This means they have the initial and final say in all trades and actions that occur.
Who Algorithmic Trading Best Suited For?
Algorithmic trading can best suit multiple types of traders.
One is for the traders that are just starting out. An algorithm can help offset lack of experience in the market. While the algorithm does the work, the investor can take the time to learn and study the market further to see how investments are carried out and how different actions are taken by the algorithm in different events.
Algorithmic trading is also well suited for those that are crunched on time. This being that they do not have the time to sit and monitor the market and daily performance. They look to have something in place to set it and let it go and just having to check on it occasionally rather than at a higher frequency.
Pros and Cons of Manual Trading
A skilled person can have an advantage in manual trading. This means that someone that is highly knowledgeable on the market can assess when there are more complex situations that software may not be programmed to pick up. These differences can help a trader determine when they meet the optimal point to make a purchase or sale.
The ability to experiment is often seen as a pro, although with someone that is inexperienced this is a huge con, because this allows someone to trade beyond a plan, whereas an algorithm will not go beyond its code. Being able to experiment with methods can allow a trader to reap more gains than staying static.
Manual trading also allows for more control. Rather than leaving trades and functions up to the algorithm, a trader gets to make all the decisions. This control can make it so you can have gains beyond what would have been with just the algorithm…again, an algorithm can’t go beyond what it is designed to.
One of the largest cons to manually trading is the sticky bit with human emotion attached to your portfolio. Emotion is a great thing to express, but in the world of financial markets, not so much. Taking a loss can sting, but if you let this rule your decisions, you will end up with potentially even greater losses.
Another con with manual trading is that the human brain can only compute and retain so much data. Interpreting data and the constant flow of information takes time, energy and effort. Often this is too much for any one person to fully grasp and understand. Due to this handicap, there can be potential losses that an algorithm would be able to pick up.
Manual trading also falls a bit when it comes to extra help. This trading method does not include offering expert advisors like many automated systems have. Algorithmic trading relies on bots, but manual trading completely relies on the human brain. So at a limited capacity to hold information, interpret information, and be able to make decisions that a bot can factor there is a bit of a short-coming.
Pros and Cons of Algorithmic Trading
One of the biggest advantages to using an algorithm is there is NO EMOTION involved. Emotion in the human experience gives way to a lot of joys, but in the world of Forex, having emotion tied to an investment can lead you down a dark rabbit hole. Emotional attachment can create irrational decisions…and these irrational choices lead to greater losses.
An algorithm also takes a hold of diversification greater than with manual trading. An algorithm allows your portfolio to be greater spread. A better spread portfolio allows for possible hits and volatility to be spread so a large hit can be diminished.
Another positive to using an algorithm is the use of backtesting. This means that as a software, the computer must do as it is told to. This means programmers have often tested the algorithm and its performance against historical data to see how it will perform in the future. This rigorous testing allows you to make more potential gains based on the research done.
Orders are also executed faster. This means that as an action is placed by the algorithm, it happens immediately. Everything operates and is done faster this way. The market changes quickly and manual traders can miss out on great opportunities due to this. By having an algorithm running the show, these potential gains are not missed.
One last pro is that algorithms preserve greater discipline than manual trading. Manual trading can often be harmed by human error. With an algorithm there are no keystroke errors and no irrational responses to volatile market conditions.
Mechanical failures can happen. As with all software and technology, errors can happen. If the system crashes, the internet fails, or anything else…a trade will not be executed and cause a great loss or missing on a potential gain.
Algorithms also require monitoring. Because of the potential mechanical failures and issues listed above, an algorithm needs to still be monitored to ensure that if these occur they are caught.
There can also be the case of over-optimization using an algorithm. When backtesting, an algorithm can look beautiful and have performed well against historical data, but when launched it may have major drawbacks. This excessive optimisation can lead to an unreliable algorithm out in the live market.
So What is Best for You?
The big question here though is what best suits you in the manual versus algorithmic trading debate. While both have some amazing advantages and downfalls with them, it all comes down to the type of trader you are and want to be.
There are a few other types of trading methods that are a bit of hybrid approaches compared to the above selections.
Copy trading is exactly what it sounds like. This is when one trader copies another trader’s patterns, methods, and moves in the market.
This is a bit more than just copying though. There tends to be a singular “Master” trader that individuals refer to. So if the master trader allocates 15% of funds to a certain transaction, those that follow that trader will allocate the same amount of funds to the same trade.
A great pro to this method is you can learn and act like a pro because you are following a seasoned forex pro using this technique.
The downside to this though is that if the original trader makes a poor choice, so do you. Also, you need to pay attention to what is copied if you want to actually learn. If you simply copy for the sake of copying, you won’t be able to pull as much from the experience.
Mirror trading is very similar to and goes hand in hand with copy trading. This has a slight difference though. Rather than following a single person and matching their moves, with mirror trading it works more like a hybrid of copy trading and algorithmic trading.
This method takes numerous high performing individuals and allows them to serve as a model to be copied. With this you cannot choose who to copy; it is chosen for you.
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