Don't Blame High Frequency Trading For Your Losers

High frequency trading (HFT) - - it's one of the Wall St. topics that causes divisions that match the polarity of the United States right now.


On one side it's an example of how large financial institutions, many of which were bailed out during the financial crisis, are running our country and screwing everyone on their path to total domination.

On the other side America is viewed as an imperfect experiment where the playing field is not equal and never will be and excuses and complaints are just the du jour reasons outsiders use to explain how the old boys club is stacked against them.

THREE KEY PARTS
I am breaking the topic of high frequency trading into three parts.


1) HFT is the use of computers and other technology to do automatically and very quickly, in fractions of a second, what a person does manually and relatively slowly.
If you buy XYZ because a condition has been met, before you put your hand on your mouse, not only has a computer at a HFT firm has already taken the position, but in taking the position, the price may be slightly different now.

Seventy percent of the market's volume is computer generated. Odds are when you buy XYZ, the counter party is not another human, it's a computer. Is this fair? Does this destroy the integrity of the market place? This will be discussed today.

2) Many HFT firms pay a lot of money to set up servers at the exchanges to get access to information and data before the rest of us. It's not that the dissemination of information and data is delayed to the rest of us; it's that physically being at the exchange with a fiber optic connection enables access a fraction of second before it appears on computer screens all over the world.

And because computers, not humans, are used to read, interpret and act on the information and data, a fraction of a second is all that is needed. Is this fair? Are traders/investors who don't have the money and expertise being discriminated against? Is Wall St. no longer a pure market place where everyone has access to the same information and data at the same time? This will be discussed in part two of this series.

3) HFT firms flash fake orders in an attempt to influence buyers and sellers. They'll flash big orders just below the bid hoping to entice buying; they'll flash big orders just above the ask hoping to entice selling.

On the floor of the exchange or in the pits in Chicago, this is impossible. Besides the fact that in Chicago a trader would get taken out back and have the daylights beaten out of him (I'm not joking), if a trader signals with his hands a desire to buy or sell and another trader hand signals to take the other side of the trade, it's a done deal. There's no going back. It's only possible in today's electronic marketplace, but many believe such fake orders should be outlawed. This will be discussed in part III of this series.

IS THIS WHY YOU LOSE?
Let's move on to today's discussion. HFT is at the top of every losing trader's blame list.

At its core, HFT is simply the use of computers to do automatically and very quickly what a person can do manually and relatively slowly. An algorithm is a finite set of instructions a computer executes. They are used to read, interpret and act on information and data. They may place buy and sell orders based on technical indicators.

Or they may place orders based on the relationship between two stocks. Or based on certain language that appears in the headlines of their real-time news feeds. The list goes on. There are hundreds of HFT firms and tens of thousands of ways to manipulate the data. Firms are literally only limited by their own imagination. Humans do the exact same thing, but we're a little slower.

Have I raised any yellow flags yet? Have I said something that made you pause and think to yourself: "that's not fair?" I'm guessing not. Certainly there's nothing wrong with using a computer to crunch some numbers faster than you could do it by hand. Yet HFT firms were in the crosshairs of the Occupy movement and are often bad-mouthed by losing traders.

Yes it's possible the presence of HFT algorithms caused your market order to execute at $50.10 instead of $50.08, so you're pissed your fill was two cents worse than it could have been, but in your argument, you conveniently forget that 10 minutes prior the stock was trading at $49.95, and you didn't pull the trigger.

You'll quickly blame HFT for screwing you out of two cents even though you could have bought earlier in the day at a lower price. And you also don't mention the times when HFT pushed prices down a few cents enabling you to get a better price or when HFT firms pushed the price up a couple pennies enabling you to make a little extra.

In the end, it's a wash. HFT firms can place orders faster than you and I, but who cares? For every time it costs you a couple pennies, you'll get a couple pennies back on a later transaction.

STOP MAKING EXCUSES
I'm not going to argue that HFT is good for the market, but I am going to argue it's not nearly as bad as you think, and if you're not making money, it's not because of HFT, it's because you're not very good. Stop making excuses. The presence of HFT algorithms running wild on Wall St. didn't cause you to hold onto that stock longer than you should have. It didn't cause you to allow that small loss to turn into a big loss. Sure you may have gotten in at $50.10 instead of $50.08, but after riding the stock up to 55, the fact that you let it drop all the way back down to $51.00 isn't the fault of some unknown computer, it's your fault. You didn't manage the trade properly.

If you're pissed HFT firms have PhD's that are smarter than you, computers that are faster than yours and trading software that's better than yours, than accept it or find another line of work.

There will always be some who have better tools than you. What makes a guitar sound great? The guitar itself or the dude playing it? My money is on the dude playing it. A great guitarist can make beautiful music with an average, off-the-shelf guitar. A crappy player will always suck, even if he has the best guitar in the store. The great thing about trading is, in your little corner of the world, you can make money regardless of all other factors.

Don't buy into the crap about "competing against the best in the world." That's completely false, and it just gives you an excuse. It gives you an unknown entity to blame when you lose money. In trading, your competition isn't "out there," it is and always will be the person who stares back at you in the mirror.

The fact that an algorithm can read a technical indicator faster than you can and place an order before you can and get a better price by a penny or two doesn't influence whether you make money or not (by the way, money is made managing positions, not brilliantly entering them - but this is another topic for another day). It wasn't that long ago the market traded in fractions and hitting the ask meant paying a 1/16th (6 cents) or an 1/8th (12 cents), not the one or two pennies you pay today.

FIGURE OUT THE REAL PROBLEM
You can buy AXP at $66 and sell it two weeks later at $69 like we did at LeavittBrothers.com. You can buy CZR under $13 and sell it at $16 - another one of our picks. You can buy BAC at 10 bucks and ride it to $12. HFT will not prevent you from executing these trades, and in each case if your entry was off by a couple pennies due to HFT firms getting in line in front of you, it would not have mattered.

If you're not making money - especially now in a super strong bull market - something is wrong with you or your trading system. You're on the wrong side of the market. You're playing the wrong stocks. You're managing your trades incorrectly. Figure out what the problem is. I have a hint. It's not HFT - even though it's convenient to blame.

TRADING IS TOUGH
Sorry for the lack of sympathy. Trading is tough. I've been on the floor of the CME, and can tell you firsthand guys who are 30 look 40.

This game will age you faster than a fast food diet. If you're going to distract yourself with silly excuses about HFT firms screwing you, go find another line of work. You have no chance of making it.