Algorithmic forex trading uses computer programs and software to trade foreign currencies on the currency market. These automated strategies can be complex, allowing traders to customise their trades in various ways. However, algorithmic forex trading carries various risks that traders must consider before making any trades. This article outlines some risks associated with algorithmic forex strategies, including data security concerns, liquidity risk, and more, as well as how traders can lower these risks.
Data security concerns
Using automated systems to trade forex can leave traders vulnerable to cyber-attacks and data breaches. Hackers may be able to gain access to sensitive information regarding trading strategies or, even worse, manipulate the trades themselves, resulting in significant losses for the trader.
One good way to stay protected and lower risks of security concerns is to make sure you never share the passwords to your third-party tools to anyone. You should also ensure that you’re trading with a secure Internet connection.
Liquidity risk
Algorithmic trading requires significant liquidity for successful execution, meaning that if markets are thin or illiquid, it could result in the trader being unable to fill their order at a price they deem acceptable, leading to losses.
One good way to lower liquidity risk is to trade markets with higher liquidity. You can also set specific market orders such as Fill or Kill to ensure that if you cannot fill out your orders at your preferred price, your order will automatically be cancelled. This is a great way to prevent slippage.
System reliability
Traders relying on algorithmic forex strategies need assurance that their system will work as expected every time they place an order. However, any glitches or errors in the software could lead to significant losses as the trader may be unable to act fast enough to rectify any issues.
One way to reduce this risk is to invest in high quality hardware and secure connections. Make sure you do not have any malware in your devices and only work with reputable and reliable brokers and servers. If you would like to trade frequently, it is also worth procuring a Forex VPS.
Exchange rate risk
Currency exchange rates are constantly changing, meaning that traders need to consider the potential for price fluctuations during their forex trade or face a potentially high degree of risk associated with such an unpredictable market.
To lower this risk, you should trade markets that are relatively stable. This means trading currencies from more stable economics, such as that of developed nations.
Shortcomings of existing algorithms
Though algorithmic forex trading strategies have become increasingly popular, it is essential to remember that they still lack human traders’ intuition and decision-making capability. As such, some strategies may be less effective when confronted with unexpected market conditions or unforeseen events in the news cycle.
Doing thorough research of an algorithm or algorithmic software before trading can help prevent you from choosing programmes that are unsuitable for trading. However, it is essentially to still keep an eye on the markets and make sure you know how to react if something goes wrong.
Overdependence on technology
Traders who rely too heavily on algorithmic forex systems risk missing out on potential trading opportunities as their system may be unable to react quickly enough to changing market conditions. The best thing you can do as a trader is to learn the basics of trading without algorithms, and then slowly incorporating technology into your methods. This prevents you from over-depending on technology.
Leverage risk
Algorithmic forex traders must also consider the risks associated with leverage. These systems often require large amounts of capital to operate effectively and therefore have greater exposure to any losses incurred by their strategies.
If you are unsure of how markets will go in times of volatility, do not use high leverage. Remember that you can always increase your use of leverage later, but you may not be able to recuperate losses once your funds are gone.
Regulatory changes
Regulations governing the forex markets are constantly changing, meaning algorithmic traders must stay updated with new developments to ensure compliance with applicable laws and regulations.
