What is High Frequency Trading?

High Frequency Trading (HFT) is an automated type of trading where algorithms are used to identify trade setups at a rapid pace and huge scale. It’s about moving in and out of a large number of orders or short-term positions where, while the margin on each trade might be low, there are potentially millions of trades happening simultaneously.

It requires proprietary algorithms, extremely robust computing equipment co- or very closely located with the exchanges, and correspondingly fast and reliable networking capability.

So why do retail traders feel threatened? Professional trading divisions or companies can afford expensive server space close to the  exchange servers (which means information gets there that bit quicker). They have access to mighty computing power and faster, cheaper and more direct access to market information. They can afford the rates of professional analysts and programmers who can successfully develop systems that process huge quantities of information in different markets simultaneously and then constantly fine-tune the HFT algorithms.

Then there is the rest of the tech team required to keep that high-speed computing power and those networks up 24/7 without fail, as these players are often placing HFT trades when the markets are closed. (See the chart below for more discussion of this).  

These many financial and technology advantages are beyond the reach of most individual traders and may make them wonder how retail traders can beat institutional traders and hedge funds. To compete with HFT, they will either need outstanding analysis and programming skills themselves or to pay the same rates that the big corporates pay to hire the experts.  And the algorithms needed for HFT require constant monitoring and readjusting – a job in itself.

But even if an individual trader can handle this, they may not have the computing or networking power required at their disposal. Meanwhile individual traders have to pay more for the same market information than the smart money players and their inferior data networks will mean it won’t arrive as quickly.

So do individual or retail traders have any advantage over companies using HFT?

There are some places in which a retail trader may have advantages over these big players. For instance, a retail trader theoretically has more freedom to trade in exotic markets which an institutional fund would not be able to enter due to  regulation. Though whether there is sufficient liquidity in these small markets to make them profitable for individual traders is another question.

Also individual traders are not answerable to anyone but themselves. If they don’t see a trade they are interested in for some time then they can wait. A large fund has investors to answer to or an investment mandate to follow.

But playing them at their own HFT game? ‘Individual traders don’t have any advantage or a chance to win’,  says Grigory Margolin, Tradeguider’s CTO.

So the real question isn’t how to beat them but how to use their activity to your advantage

 ‘There is one very big “but”’, he adds though.

‘If retail traders are able to identify the intention of the professionals, whether long term or medium term, they may follow them. For example, if we are thinking that professionals are bullish for the day, week or for the month, why don’t we follow and take the long scalping or intraday trades?.’

Let’s see this in action

Here is a chart showing trades in US Bancorp (ticker symbol USB traded on the New York Stock Exchange) from 18^th October 2021. It was created using VSA Lite, our entry-level charting package and the fourth and newest addition to our suite of software packages. 

At 9pm London time we see 1.67 million shares were traded within a five second gap – a clear footprint left by high-frequency trading after the market has closed. ‘We can’t say whether it’s one particular company or a group of companies but we see that happening all the time,’ says Grigory.

So whether we’re using VSA Lite or Chart Center, Smart Center or Smart Center Pro [ins links], we can take the same approach: we get ready to look for additional VSA confirmations as soon as the market opens the next day. These will point out the direction of trades made by the smart money.. We can then identify a trade setup and place our trade in harmony with their trading direction. Rather than having to ask ‘how does high frequency trading work’ or research high frequency trading strategies we can use our existing Wyckoff VSA skills and knowledge here too.

Summary

Long story short, retail traders cannot compete with HFT groups but they do not need to. Any professional activity, including HFT, will leave a footprint on the chart and signal their trading intentions. Wyckoff VSA helps us identify these and individuals can pick up profits by following them. Even if these gains represent a fraction of the money the big companies make, it may still be good enough to satisfy the needs of the trader. 

Sources

The wild west of high frequency stock trading - Jake Tran

Why technical `analysis` is garbage (explained by a quant developer) - Coding Jesus

Risk management: prop trader vs day trader - Coding Jesus

Is algorithmic trading profitable for retail traders? - Quora

What are your thoughts on algorithmic trading for retail investors? - Quora

Can a Retail Trader do Algo trading? - Quora

Has High Frequency Trading Ruined the Stock Market for the Rest of Us? - Investopedia.com

4 Big Risks of Algorithmic High-Frequency Trading (investopedia.com) - Investopedia.com

High-frequency trading - Wikipedia