What is High Frequency Trading

High frequency trading, Wall Street Trading Error

High frequency trading, Wall Street Trading Error—Mike Licht NotionsCapital.com (Flickr.com)

High Frequency Trading is:

  • Usually based upon TA
  • Investments based upon time frame
  • Day trading, no positions after close
  • Sensitive to electronic trading platforms and communication.

High Frequency Trading is usually based upon upon short term human psychology rather long term human wants and needs. That is to say, its based upon emotions. Particularly Greed and Fear.

The shorter the time frame the more emotional the trade.

Time Frames

High frequency traders sometimes seek to profit by trading one time frame for another. For example:

If there is a selling panic in the market, a day trader may decide that the market is over reacting and will begin losing money buying against the trend of the market now in the hopes that sellers will come to their senses later. This way they can profit from buying back their shares at a higher price later. Conversely, they may jump in on the panic short selling and attempt to dump their shares at the lowest price possible without crossing time frames.

The market swings are essentially made up of buyers and sellers entering and exiting their positions according to their time frames.

Low frequency long term investors buy larger positions, using the added liquidity of high frequency traders to obtain better pricing. They usually base their trading decisions on fundamental reasoning that occurs over a longer period. High frequency traders attempt to profit from the distortions created by large position traders as well as emotionally fueled deviations in market movement.

Technical Analysis

Traders of a High Frequency nature will often use what is referred to as “Technical Analysis” which generally refers to the study of chart patterns and statistical price movements across different time periods. Because the term “High Frequency” is relative, the term can be applied to almost any type of trader, be it a day trader (who closes all positions before the end of day in exchange for higher leverage), a swing trader who takes positions that can last weeks, or even a hedge fund manager who is very actively increasing and decreasing their large long term positions each day.

For the purposes of making high frequency trading profit from your own home, we are going to focus on the first 2 mentioned.

Why are high frequency traders needed?

  • Market making, specialist, bid offer spread,
  • Arbitrage
  • SRO

Believe it or not, as a high frequency trader you offer a very valuable service to the stability of the overall market and economy. Day traders and other high frequency market participants account for nearly 75 percent of all trading in U.S. Equities, and serve to protect the market in many ways, including:

  • They increase competition creating a tighter bid ask spread allowing retail investors to buy at a fair market price
  • They seek out arbitrage opportunities maintaining price integrity and consistency
  • The provide liquidity to prevent both market panic and market manipulation
  • They disperse the power and responsibility of maintaining a fair market through its participants
  • They help stabilize the market

Without the liquidity of high frequency traders, the market would always be on the verge of collapse.

What do you need to get started in High Frequency trading?

  • A fast internet connection
  • A Trading Platform
  • Investment capital ($25,000 unless prop trading, Forex, or outside the U.S.A)
  • A Trading Strategy

High Frequency Trading Internet Connection.

You can day trade stocks, futures and currencies with a DSL, Cable, Satellite, or other high speed internet connection. Obviously, the faster the connection the better, but the stability of your connection is actually paramount. You don’t want to be stuck in a position during the next flash crash with a bad internet connection, as its a danger that could well wipe out your entire account and more (since most high frequency traders use some form of margin.)

You will want to have a back up battery for your connection that includes surge protection to your Ethernet connection.

High Frequency Trading Platforms

When you are competing with brokerage firms that can execute trades in less than 10 microseconds you need the fastest internet connection available in your area, but you also need a good trading platform to execute trades. Trading Platforms play a bigger role when trading stocks and futures since most Forex platforms offer near instantaneous fulfillment.

When choosing the platform, you want to make sure hot keys are supported (you can place orders with the function keys or macros and not just the mouse) as most day traders and high frequency traders compete against algorithmic programs that place orders at lightning fast speeds.

Investment capital

You can go as low as zero. Some prop firms (proprietary trading desks) will train you to trade their capital for a profit sharing opportunity. This can range from 5% to 100% take home on your end with varying commission structures.

If you want to place trades from your own account at home you will need to have an equity balance of $25,000 in your account if you wish to place more than 4 in out trades within a 5 consecutive business day period. If you do not have this much capital on hand the highest frequency you can trade will be “swing trading”

There is no day trading limit on the forex markets (trading currencies) and each firm has a different minimum requirement.

So how you make money in high frequency trading?

Here is a brief idea behind the most common high frequency trading strategies

Market Making:

This generally refers to the act of trade facilitation by placing offers to buy and sell shares outside the current price. A true market maker will work for a broker-dealer, but high frequency traders can make money in a similar way known as “Rebate Trading” where the exchange pays them when their posted shares get filled

Tape Reading

Most day traders prefer to focus on the tape or “time and sales” since it shows actual transactions that have taken place. This helps them remove emotions from their trading decisions.

Statistical Arbitrage

Essentially, high frequency traders will attempt profit from price changes in a security, commodity or currency that occur outside the historical statistical norm. This strategy is not without risk, and will sometimes result in a larger loss if the change in price relation is permanent.

Trading the News

Another common way to profit in high frequency trading is called “Trading the News” This refers to waiting for the market to react in sometimes extreme and violent ways to particular events. This will usually involve economic releases, company earnings, or other news that is thought to change the long term outlook of a security or currency.

So What is High Frequency Trading?

Its all about risk. If you can manage risk properly, you should be able to stay alive long enough to reap the rewards.