Gaming the High Frequency Trading Programs (HFTs) for Fun
There has been much debate and controversy about the negative effects of high frequency trading programs (HFTs). The arguments range from stealing market liquidity, price manipulation, and unnecessary volatility to being responsible for the flash crash. While there are many negatives to these programs, many are misguided as to the effects they have on the market. Equity HFT programs tend to lift markets not collapse them, albeit in an artificial manner. Artificially propping up prices results in a hollow core that produces more violent crash like sell-offs. We saw lots of this last year. In fact, HFT activity was rampant last year, but the volatility was just too much of a shock to the system. The media and government scrutiny has diminished much of the activity. While the masses may think this is good for the markets, for traders, it’s a bane. HFTs and traders feed on two things, volume and volatility.
This is a market where mechanics override fundamentals, just as liquidity overrides price and machines override humanoids. The volatility has actually dropped dramatically since the beginning of this year, yet, we are still scarred by the effects of the 30 point S&P futures gaps up and down that we saw all through last June-October. Just as human participants have dropped, so have the computer participants. Last years crazy volatility took a toll not just on humanoids but also the machines, which is the real reason for the lack of volume all year long, the lowest in five years!
These programs were running amuck causing retail traders to pay the highest prices for positions and then rug pulling out investors when they wanted to sell. This crazy volatility has burnt untold scores of retail investors and traders as they left the markets all together. The damage was done severely last year. Mutual fund outflows continues to rise even as markets seem to ‘float’ higher while the economy seems to be barely chugging along with little to no improvement. Market volumes are at five-year lows and yet equity markets are trading near their five-year highs! It’s not the retail guy causing this, but the algo programs. They prop up the market at inflection points to knee jerk the institutions to buy and then back off. If they do their job right, that hollow core will get filled out with institutional bids that get lifted. Rinse and repeat… bam yearly highs! Same thing happened from October to December last year as the SPY floated from 117 to 132 on tumbleweed daily volume. Same thing is happening now. HFTs have been tamed a bit and know their role.
While there are numerous types of trading algorithms in the markets, I’m just focusing on the specific HFTs that provide the coiled spring like price movment. I’m only addressing the resulting price movement. One thing is that HFT’s provide for sure is price movement while liquidity, hopefully, is provided by the participants.
If successfully executed, HFTs can generate hours and even days worth of gains in minutes. The first 90 minutes of the day and last 45 minutes of the day is when the HFTs are most prevalent. They are most prevalent in the highest volume movers which include big ten gappers and dumpers of the day as well as the top tier of the S&P 100 stocks. If there is one word to describe the effects of HFTs, it’s magnify. They magnify the price movements in concentrated spurts of activity during specific periods of time.
The best way to game the HFTs is to go where they roam. As they say, don’t bring a knife to a gunfight. HFTs leave a lot of victims along the way, so you better have a strong trading method/system in place. The key is to buy early and sell into the momentum. You have to have a method or system to play these effectively. Most importantly, you have to take your money and walk away. The more you tangle with HFTs, the more chances are you will give money back. This is why it’s important to hit and run before the tumbleweeds set in. This is called the liquidity trap. There is nothing worse than a flat, light volume, tight ranged choppy limp market.
HFTs can magnify a .15 scalp profit to .30-.50-.70 or more if timed correctly. We are talking hours worth of price movement generated in a concentrated 20-30 minute time period.
There are certain patterns that capture these magnified moves, which are mostly found within the first 30 minutes of trading during the highest points of volatility. The key to gaming the HFTs is having a consistent trading method/system that feeds on volume and movement with the ability to foreshadow impending breakouts/breakdown and can get you in at the optimum moments at the point of impact to ride the HFT driven momentum. Play where the HFTs dwell and exit early into the momentum. Don’t try to squeeze out the last drop. That's where you get into trouble. I’ve learned that having the ability to get out ‘early’ with profits consistently is not a curse but a talent. It means you are finely calibrated to the liquidity… and due for a pay raise by scaling up shares over time. Any fund manager will tell you that liquidity overrides price, but that’s another subject for another day!