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After doing a bit more research on algorithmic FX trading, I’ve decided to add another article in this series. This time, let’s look into proposed regulations for this part of the forex industry.

If you’re just tuning in though, make sure you review the first three articles on this topic:

Part I: Definition and Advantages of Algo FX Trading

Part II: Types of Algorithmic FX Trading Strategies

Part III: Recent Developments and Drawbacks

As I’ve discussed, algorithmic forex trading does hold a lot of potential in terms of trade execution and profitability. There are plenty of strategies to choose from and one can be able to create a customized trading system with a background in the financial markets and programming knowledge. However, there have been some instances where system glitches have disrupted financial market activity, leading to calls for increased regulation.

Other financial markets which have also seen the rise of high-frequency algo trading activity could see stricter regulation, as the CME Group has already started discussions on algo trading regulation in the futures market.

“The market structure and multi-leveled protections in the futures markets strikes the right balance of regulating the market without inhibiting true price discovery,” mentioned CME Group Executive Chairman and President Terry Duffy. “This balance of regulation and surveillance, liquidity and access, gives farmers and businesses, and money managers and traders, the confidence to rely on our markets to effectively manage risk.”

In addition, the issue on the tightening of spreads in the forex market has been raised, with various options on how to ensure efficient order execution even in highly volatile market situations also discussed. This stems from the New York Federal Reserve’s research paper on how high-frequency algorithmic trading impacts market liquidity.

Some rules proposed by European regulators include limits on the ratio of unexecuted orders to open transactions and license requirements for algo trading service providers. Time limits in between trades executed were also suggested. Apart from that, provisions on flagging trades executed by algorithmic systems could also be added, as this would allow regulators to keep track of strategies that might be abusive or pose a threat to financial markets.

Earlier this year, the German Parliament already voted to adopt the High Frequency Trading Act, which covers licensing and documentation for algorithmic trading practices in the country. Regulators expect this rule to be incorporated in the European Commission’s MiFID (Markets in Financial Instruments Directive), which would pave the way for implementation among all countries in the region.

U.S. regulators appear to be more open to algorithmic trading activity though, as many officials believe that the market benefits outweigh its risks. In the same New York Federal Reserve paper on high-frequency algo trading, research officer Ernst Schaumburg asserted that these strategies enhance electronic trading efficiency and market liquidity, with strict restrictions likely to limit these advantages.

What’s your take on the recent regulations proposed and implemented for algorithmic trading? Do you agree that the forex market could benefit from less restrictions in this aspect? Don’t be shy to share your thoughts in our comment box!