High Frequency Trading Strategies

types of profitable high frequency trading strategies

strategy—Sean MacEntee (Flickr.com)

A High Frequency Trading Strategy is a strategy that is developed for the purpose of profiting from short term market fluctuations. The implementation of these strategies can be carried out by a computer or a human (a high frequency trader) but more often than not, high frequency trading strategies are implemented by a partnership of both a trader and a computer .

High frequency trading can refer to any trading strategies that attempt to make money off the repetition of price movement in the market. The higher the rate of repetition (or frequency) the higher the profitability of the strategy.

High frequency trading strategies are made up from 3 fundamental aspects of trading including:

1. The Setup, which refers to the pattern that entices a trader to enter
2. The Risk Reward, which weighs the entry against the probable exits.
3. The frequency of occurrence, which deals with how often the trading opportunity arises.

When all these factors are taken into account, you increase the probability of creating a highly profitable trading strategy for a fast pace market.

First we will deal with:

High Frequency Trading Setups.

A set up is the beginning of a pattern that you as a trader have deemed to be profitable, and is usually preceded by a trading signal like a technical indicator or potential catalyst (market mover). Remember, every profitable trade has with it an entry, exit, and catalyst (the catalyst is what is going to create the price action, so its “the reason” for taking the trade).

Without these 3 “predetermined” factors, you do not have a trade.

For example, you may notice that after the 5 minute moving average crosses the 60 minute moving average, the stock or currency you are trading goes on a bit of a run. In this case the trading signal is your catalyst or “reason” for taking the trade.

Another catalyst could be a news or earnings announcement. You may notice that when interest rates get lowered, bank stocks rise. Here your set up could be to wait for a interest rate drop and then buy bank stocks. Thus, the “set up“ is the announcement that there will be a live interest rate decision or FOMC meeting.

However, even with this knowledge of opportunity, you still need to weigh in the Risk Reward ratio of your high frequency trading strategies.

Which brings us to:

Entries and Exits of High Frequency Trading Strategies.

Your entry will be based upon your predetermined exit and your exit will be determined by your target profit over 100 trading set ups. If the set up works 50% of the time, your profit exit needs to be a greater amount than your loss exit for the set up to be profitable.

For example. If you have an entry price of $100 in stock or currency xyz and you are using a risk reward entry exit ratio of 2-1, your profit exit may be $110, while your loss exit may be $95.00. This means you make $10 for every $5 you lose if the trading set up works 50 percent of the time. If the set up works only 1/3rd of the time you will lose $5 twice for every time you make $10 leaving your risk reward entry exit at break even.

This is important to realize since most amateur traders punch out of trades before their time due to the fact that price action does not move in one single direction. Because price action is volatile, it is very likely that a trade will move against you or in a direction towards you exit. This gives the trader the instinct to cut losses early which deviates from their risk reward analysis and leads to unprofitable high frequency trading strategies.

A High Frequency of the number of set ups in the Trading Strategy

As mentioned previously, the higher the frequency of profitable trades, the more profitable the trading strategy will be. This is why you need to do research as to how often the set up occurs. If you are a day trader trading interest rate announcement you may only be working 4 days a year. This means you need to ad other set ups to your overall trading plan. Once you have one profitable strategy you can move on to a new one. This may mean you trade other set ups related to interest rate changes or other types of stocks or currencies. It could also mean that you add other types of “news” where you look for different news announcements that affect different securities in similar ways. Of course once you can trade multiple set ups for profit you can also attempt to add other unrelated strategies to your trading plan. However, it is important that you know which high frequency strategies are past the development stage and that you do not try to develop too many trading strategies at the same time. The better you understand each set up, the better your ability to make profit.

Another way to measure frequency are trades that can be completed more than once within each set up.
For example, you may be able to trade off the same support or resistance level multiple times. If there is strong support for a stock or currency at 100 you can buy shares with the intention of selling if the support levels break (say 99). This means you can buy and sell each time the stock bounces at the 100 level until it breaks. This analysis is a bit more advanced because price has a tendency to triangle at support and resistance levels, meaning the risk reward ration gets smaller and smaller after each bounce. However, this type of high frequency set up can be very exciting as the profits build up very quickly in a short amount time.

As you can see, there are two types of frequency, the number of set ups within the trading strategy and the number of trades within the set up. If you can find set ups like these that fit within your overall risk reward analysis you will greatly expand the profitability of your high frequency trading strategies.