Over the last few years, there has been a lot of talk about how high frequency traders make it difficult for the average investor to make the returns in the stock market that they use to be able to make. On one level, this is true, but on many others it isn’t. Investors still have a lot of opportunity to grow their money over the long term in a number of different areas of the stock market, and high frequency trading should have little effect over the course of several years.
But to those that are occasionally buying and selling a stock right away, high frequency traders do have an impact. For this reason, all traders should know what HFT is, and how to use it to their advantage rather than let it negatively impact their ability to make profits in the markets.
What is it?
First off, let’s start with a definition. High frequency trading is a method of trading that allows someone to move in and out of a position within just a few seconds or minutes, all with the intent of capturing tiny profits. Sometimes, this is just a few pennies per trade. Over the course of a day, there can be hundreds of trades made, and the tiny profits end up turning into a large number. It is something that the human mind alone is not capable of, and as a result, HFT uses complex computer algorithms to look for risk and reward, and then trades are executed automatically straight from that software program.
What is the Impact?
HFT seems like it should have little impact upon your trading. The organizations that use HFT are typically huge institutional traders though, like hedge funds, and the amount of volume they produce is much larger than anything you or I will ever trade. For this reason, the supply and demand that they create can have an immediate effect on prices, especially in the stock market. A big spike in volume in a certain direction can sometimes influence the rest of the trading day, and this is where HFT has established its reputation. If the volume for a small stock is doubled or more in a single moment, there is potential for that stock to feel the repercussions for days afterward as traders scramble to compensate for the momentum that has suddenly been created. The long term impact should be minimal, if anything, but for those trying to trade a stock over the short term, plans can be ruined and your strategy may need to be reconsidered.
In the Forex market, the price changes will not be as significant because currencies are traded much more heavily than stocks. This doesn’t mean that HFT can be disregarded, though. It’s still important because it can be a signal of what is yet to come.
What You Can Do
Besides price action, you need to pay attention to volume trends–regardless of where you are trading. Odds are you will not have the financial resources to ever effectively be a high frequency trader–you will need tens of millions of dollars to begin, and more to do it right–but you can still watch what these firms are doing to get a feel for how you should proceed. It’s a strategy similar to mirroring the big banks and mutual funds. Hedge funds can be a bit more secretive in their positions because of SEC and FINRA laws, but you can still watch trends and pay attention to what is going on. For example, if you see where HFT have acted in the past and see a similar situation setting itself up, look at history and see where prices have gone in similar situations. This won’t protect you 100 percent, but it will allow you to make a more informed decision.
Sticking to forms of trading that are more insulated will also help you. Forex trading, the commodity markets, index funds and ETFs, and the binary options market all have a degree of separation from HFT and can be easier to protect yourself within.
High frequency trading is not a bad thing, like many pundits will have you believe. It is a healthy part of our economy, and it is something that you can use to your advantage. Within the Forex market, you can even jump in on some of this as many trading robots and expert advisors have been created to allow you to mirror high frequency trading in real time as trades are made by professionals in one place, and your account automatically makes the same trades. This isn’t for everyone, but it is a consideration.
If you want to stick to day trading stocks, awareness is best. HFT is basically a frontrunner here, and it’s true that in their most profitable spots, they will beat you. But, that doesn’t mean that it will cut into your profit rate. In fact, if you are already day trading, it’s hurting you more than it will once you’re made aware of it. Pay attention, and you can use this to boost your rates higher than you ever have before.