High Frequency Trading and Traditional Trading – how are they different?
High frequency trading is very different from traditional trading strategies. Of course, the principle is still the same, buy low and sell high, but the details are very different. Most investment strategies, especially those used by casual investors and beginners, focus on holding onto stocks for an extended period of time as they slowly appreciate in value. With high frequency trading strategies, however, investors instead will often hold onto stocks for a short period of time. This can sometimes be as short as a few minutes.
HFT and Price Movements
High frequency trading is often predicated on price movements. Investors will essentially look for abnormalities in price movements, perhaps a large upwards or downwards swing in prices in a short period of time. They will then execute trades based on these movements. Generally speaking, markets are relatively stable and have a tendency to “smooth out” over time. To be clear, this is a simplification, but one that generally holds true over time.
Price movements can create opportunities to make money. If investors overreact to a bit of news, such as a quarterly report, or simply sell because others are selling, stock prices could drop more than is justified. At this point in time, the stocks themselves would be a good buy. Of course, many HFT strategies rely more on price movements, and programmers can build entire algorithms to analyze a huge range of factors.
Markets can change quickly. This is especially true in regards to the types of price changes that enable high frequency trading. Fact is, high frequency trading is so reliant on speed that many humans simply aren’t fast enough on their own. Luckily, however, traders can now use trading computers, software, and other tools to automate trading. Many of these tools rely on algorithms to set up parameters and guidelines for software programs to then execute trades on their own.
High Frequency Trading Software Has Revolutionized The Game
High frequency trading software has become a vital part of trading strategies for many investors. Basically, investors will either use a variety of pre-built algorithms or will design their own algorithms. These formulas will contain a list of rules and factors. They will allow the software program to basically watch markets on their own. When a certain event occurs, such as a price dropping or rising but a certain level, the software program will execute a trade on your behalf.
Sometimes, HFT strategies may rely on a “black box” that will provide outputs for traders to then conduct their own trades. These black boxes often won’t tell traders exactly how their formulas work, so there is a high level of trust involved. They can be useful, however, for providing key insights into data and for analyzing a wide range of factors.
While price is perhaps the most common and popular factor to be monitored, it is certainly not the only one. High frequency trading algorithms can consider a wide range of factors, such as volume, weather, overall market conditions, information from financial reports, and numerous other factors. More or less, if you can quantify it, you can probably put it in your trading algorithm.
Taking Your Algorithmic Trading Knowledge to the Next Level
Some popular stocks for high frequency traders include Apple (AAPL) and AT&T (t stock). Popular stocks for such traders are often very volatile, creating lots of price movements. T stocks, for example, have been popular because AT&T has been suffering from tough competition and changing consumer patterns. Often traders, however, overreact or exhibit a sort of herd mentality. Due to this, opportunities to make money off of price movements frequently emerge.
Obviously, this article only brushes over the complexity of high frequency trading. If you are interested in this subject and are thinking of using it for your own trading efforts, you should definitely consider reading a high frequency trading book. There are many great algorithmic trading books out there. Some of them are:
- “High-Frequency Trading: A Practical Guide to Algorithmic Strategies and Trading Systems ” by Idele Aldridge and
- “Inside the Black Box: A Simple Guide to Quantitative and High Frequency Trading” by Rishi K. Narang.
There are many other great options out there, so take your time and find a book you are really comfortable with.
Even if you don’t plan on using algorithmic trading for your own efforts, understanding how and why such trading efforts work could help you understand more about markets. This can help you as an investor, even if your preferred investing method is value investing, or anything else. So make sure you consider the field, and take some time to learn more!