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.

20 Comments

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ALSITRADER: Don't Blame High Frequency Trading For Your Losers http://t.co/DnWOZ9SH51
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Visitor - Richard Salyer: A lot of this article is pure BS. Flash trading is front running bids without any capital committed to the trade. Purely Illegal. Let's call it for what is is - cheating every day investors once again. I say SEC, get your s*&t together and stop this and start doing your job, or expect we the citizens through our
Congrfesssmen and Senators just eliminate your whole Department in the Federal Government. Yea, we're pissed!
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Visitor - Seng Siong: Great article for education. Though we are slow but we can get ahead of the market through pattern. Don't blame other, you are responsible for your actions.
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skylanetk: Why don't you go look at Accenture on the Flash Crash Day. It was at .01 cent, one penny. Was the flash crash and the dozens that take place each week in individual issues liquidity and stability?
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SteveMiller: Those cases are rare. Overall, HFT has been very good for the retail trader/investor. Like I said, there are reasons to dislike it.
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SteveMiller: Nice Article! For my trading, I really dislike HFT. Its taken all of the noise out of the market for active traders, as HFT companies are thrilled to trade inside the penny. Scalping the market used to be my bread and butter, moving in and out and finding an "edge". Real or not HFT creates massive liquidity and stability. That's, of course, is great for the retail investor, as it brings execution costs way down.
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Visitor - Jason Leavitt: Interesting point of view. The beginning of tough times for scalpers started when the market went from fractions to decimals. HFT certainly add stability and liquidity and forces spreads to be smaller. Comment...
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JasonLeavitt: Interesting point of view. The beginning of tough times for scalpers started when the market went from fractions to decimals. HFT certainly add stability and liquidity and forces spreads to be smaller. Comment...
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skylanetk: While I agree with some of what you say there are still issues with HFTs. They can trade out several decimal places, enableing them to always be at the front of the que. This allows them to trade against the deck. It also enables them to get paid for order flow instead fo pay. This means that they are really in most cases taking liquidity not providing it. Their algos also cause flash events both up and down that stop people out. I am not talking about stop runs of just taking out a prior high or low by a couple of cents, I am talking about events that are several percent or more off the market(flash crash). That type of event never happened on the floor. Many exchanges offer special order types to HFTs that ordinary customers do not have. HFTs are under investigation for crossing trades, all kinds of issues here. There are several other issues, an excellent book onthe subject is "The Problem of HFT" by Haim Bodek, is is a short read.

Also in your article , you mention flashing in orders in an attepmt to influence other traders. While I don't know anybody that got beat up for that kind of behavior, I do recall many people getting written up and fined for making bids and offers that they had no intention of honoring. Jason, although I do not know I do think there may be plenty of naked short selling or at least offers far in excess of stocks or etfs available. I am alos concerned that the HFTs are placing orders far in excess of their capital(Knight come to mind). Some of your subscribers may have traded for a long time(25yrs here) and some may not trade alot(I have traded almost everyday). In my experience the flash events and some other market behavior that I have experienced in my opinion justifies some of the ridicule that HFTs receive. I would like to hear about some of your subscriber's views . (and I haven't talked about the options markets).
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Visitor - Jason Leavitt: Thanks for your comments skylanetk. I agree HTF should not be given special treatment, but that's not a HFT issue, it's an SEC (or some other government body) issue. By saying this you're not against HFT, you're against HFT firms playing by a different set of rules. I agree with you. If you and I can only go out 2 decimal places, HFT should be limited to the same. But, I can't overemphasize this, whether I buy a stock at 50.08 or 50.09 and then sell at 55 doesn't really matter. Money is made and lost managing positions, not brilliantly pin-pointing the exact entry.

And you're right that flash crashes never happened in the pit. All I can say is: oh well. It's a new world we live in. Adapt or die. Complain or make an adjustment.

My whole point was traders can in fact make money even though a high percentage of volume is computer generated. I choose to focus on what I can control, and I don't worry about much else.
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JasonLeavitt: Thanks for your comments skylanetk. I agree HTF should not be given special treatment, but that's not a HFT issue, it's an SEC (or some other government body) issue. By saying this you're not against HFT, you're against HFT firms playing by a different set of rules. I agree with you. If you and I can only go out 2 decimal places, HFT should be limited to the same. But, I can't overemphasize this, whether I buy a stock at 50.08 or 50.09 and then sell at 55 doesn't really matter. Money is made and lost managing positions, not brilliantly pin-pointing the exact entry.

And you're right that flash crashes never happened in the pit. All I can say is: oh well. It's a new world we live in. Adapt or die. Complain or make an adjustment.

My whole point was traders can in fact make money even though a high percentage of volume is computer generated. I choose to focus on what I can control, and I don't worry about much else.
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BobLang: awesome article Jason.
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Visitor - Jason Leavitt: Thanks Bob.
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JasonLeavitt: Thanks Bob.
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Visitor - JimB: Another outstanding article by Jase
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Visitor - Jason Leavitt: Thanks Jim.
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JasonLeavitt: Thanks Jim.
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Visitor - Sam: Hi Leavitt, I think you're right on spot. When you are free trading in an ocean of Giants, like Countries, and Huge firms, you would be better off to be 'part of the system' than try to argue and fight the play.
Yes, I'll be looking for your next article.
All the best
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Visitor - Jason Leavitt: Comment...Thanks Sam. If traders dislike HFT they can do one of three things. 1) Quit and never trade again. 2) Go to Washington and march for change. 3) Accept it and figure out a way to make money despite its existence. I choose #3.
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JasonLeavitt: Comment...Thanks Sam. If traders dislike HFT they can do one of three things. 1) Quit and never trade again. 2) Go to Washington and march for change. 3) Accept it and figure out a way to make money despite its existence. I choose #3.
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