High Frequency Trading – seven points of understanding.

A large part of the daily volume in Stocks, Futures, Options, Commodities and Exchange Traded Funds is now being generated by High Frequency Trading firms that use computers to generate a small statistical edge for their trading. Since traders like us also use computers, the difference between us and HFT lies in the nature of computers.

In the computers used by HFT, many programs operate in nanoseconds (a billionth of a second) which requires very high speed computers and programming languages that work just that fraction of a second faster. Our computers are much slower, which makes one of the differences between the technical trader and the HFT firm.

Most of the programmers used by the HFT firms have PHD’s or masters degrees in engineering, mathematics, programming or quantitative techniques. They are called quants. The best ones make one million dollars a year. Some algorithms hold positions for a fraction of a second, while others for an hour or two. The models used to trade the markets use large volumes of data to capture very small movements. Volumes are high so the small movements multiplied by large volumes give profits.

This is the background in which I started my thinking on HFT’s and how they will affect the technical traders.

First, HFT’s are here to stay, so we have to accept this.

Second, Traders must keep on writing to Ministry of Finance, SEBI and stock exchanges to ensure that the firms using HFT do not misuse their power, and adhere to the guidelines set for them. That’s important so that the large players do not get away with dishonest practices.

Third, If HFT’s are making money, then who is giving them the money? I believe that it is the retail and technical trader who is taking the other side of the trade – the losing side.

Fourth, technology will help the technical trader. It is only a matter of time before the computers available to traders become fast enough to match the speed of the HFT computers. Then what?

Fifth, Most HFT firms are using the same data to gain a statistical advantage. They are competing with each other to get that advantage just a split second faster. It is a matter of time before the advantage becomes so small as to be unprofitable.

Sixth, In spite of all the technology there is a reason why the HFT firms are focused on the microsecond trades. The reason is simple – this is an area in which the technical trader cannot compete. The best computers and programs are not able to make money in the larger time frames – hours to days. That is the area in which the human brain remains superior.

Seventh, because the algorithms developed by the quants are statistically based, they may actually enhance the efficiency of support, resistance and trend. That should be good news for technical traders.