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Artificial Intelligence and its influence on Forex Markets

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04 Oct 2024

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It has been quite some time since the Artificial Intelligence (AI) buzz took the market. As the days passed, AI has been integrated into various departments, and even individuals use it to execute various tasks. The AI functions by creating models that can analyse inputs and make predictions or decisions without human intervention.

These models are trained using machine learning, a subset of AI, where they improve over time as they are exposed to more data. The process begins with data collection, which is then cleaned and organised for the AI to process. Let’s understand how AI influences the forex market.

What is the forex market?

Forex trading is legal and regulated in India by the Securities and Exchange Board of India (market regulator) and the Reserve Bank of India. Traders in India are allowed to engage in currency pairs that have the Indian Rupee (INR), such as USD/INR, EUR/INR, GBP/INR, and JPY/INR. Additionally, you can trade cross-currency pairs like EUR/USD, GBP/USD, and USD/JPY.

How does AI influence the forex market?

AI is helping investors like you by assisting in the following areas:

1. Pattern recognition

AI allows you to spot trends that could indicate future market movements. For example, suppose you are analysing currency pairs. Your AI system identifies a recurring pattern, similar to a 'W' shape on the chart, known as a double bottom. This pattern suggests that the currency pair might increase in value soon.

Acting on this insight, you decide to buy before the expected rise and position yourself to profit from the upcoming change.

2. Automated trading

AI is known for processing vast volumes of information, identifying trends, and making decisions swiftly.

This technology helps you by performing tasks that require precision and speed and are beyond human capabilities. For example, suppose you set up an AI system to buy USD/EUR in a highly volatile market when the 50-day moving average crosses above the 200-day average. The AI monitors real-time data, and when the condition is met, it executes the trade without human intervention.

3. Sentiment analysis

AI evaluates public opinions to predict currency movements. For example, an AI system might analyse social media buzz around the USD/INR pair. If the sentiment is largely negative due to economic forecasts, the AI could infer a potential drop in the USD’s value against the INR.

4. Backtesting

Backtesting means using historical data to assess the performance of your trading strategies. For example, you might backtest a strategy that buys currency pairs when a certain technical indicator hits a specific level. If historical data shows this strategy would have been profitable, you may use it in real trading.

5. Demo trading

Many trading platforms nowadays provide demo trading features. Integrated with AI, this feature allows you to practice trading in a virtual market that does not exist in real life.

For example, you might open a demo account and receive a virtual balance of INR 50,000. You can then use this balance to buy and sell currency pairs, such as USD/INR, and track their gains or losses as if trading with real money.

This practice helps you learn the platform's features, test strategies, and gain confidence before transitioning to a live account.

Read More: What is a Demat Account?

Risks of AI in forex trading

If an algorithm is too finely tuned to past patterns, it may fail when market conditions change.

AI systems, like any technology, are susceptible to glitches and malfunctions. A technical failure could lead to significant financial losses if trades are executed erroneously or not executed due to system outages.

The predictions made by AI are only as good as the data fed into them. Inaccurate or incomplete statistics can lead to misguided trading decisions.

AI systems are exposed to hacking and other cyber threats. A security breach could lead to compromised trading strategies or unauthorised transactions, resulting in financial loss.

Conclusion

AI is transforming the forex markets by allowing for more complex trading strategies. It also helps improve risk management and increases operational efficiency. Despite the benefits, integrating AI into forex markets also presents challenges. There are concerns about the lack of transparency in AI decision-making processes. Moreover, overreliance on AI could lead to systemic risks.

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