This week’s question is from Rick Steves who asks:
Is High Frequency Trading A Good Or Bad Thing For FX?
What a great question and it has been getting a lot of attention recently. Let’s first answer the What and the How and the Who.
What is High Frequency Trading?
It is basically letting computers take over your trades and getting in and out of positions very very fast; faster than any human could manually trade, in seconds or fractions of a second.
How is it done?
The trades are done based on complicated algorithms and trading strategies on super fast and gigantic computers. It’s practically a game of who got in and out of the market first and faster. It’s like running into Macy’s first thing in the morning on black Friday, getting the best things for the best price and reselling them for a higher price to the next person. And then doing it a million times more. In forex, it’s practically betting on every fraction of the moves the currency pairs make on the forex dance floor.
What’s good about High Frequency Trading (HFT)?
You get in an out of the market aiming for small profits, sometimes just a fraction of a cent or a pip. But if you multiply that by millions of transactions done in a day? Yep. The amount can become humongo. Also, many researchers believe that high frequency traders are good for the market in general because they produce more liquidity and lower the spread.
What’s the bad?
Sometimes algorithmic and high frequency trading lead to extreme volatility as it did in May 2010 Flash Crash when high-frequency liquidity providers rapidly withdrew from the market. The Tokyo Stock Exchange had to shut down twice in the past six years because their systems could not handle the volume of traffic. Some researchers believe the use of HFT will make the trading and regulations on the FX market more complex and it also becomes a question about fairness.
What’s the ugly about HFT?
Some people believe that HFTs also help central banks manipulate the forex markets and that regulatorsignore all the FX manipulations conducted almost exclusively by algos as long as it goes in their favor.
Who trades on High Frequency and who shouldn’t?
Mostly, ultra smart computer geeks who are equipped with super expensive and fast computers are successful in this. Those are the ones who can even move the markets and create volatility and liquidity because they are trading such huge amounts so rapidly. We’re talking about hedge funds, large firms and banks who trade millions of dollars everyday. Now is this something that a sophisticated retail trader like you and I would want to do? Our students at Invest Diva would already know that the answer is a big fat NO.
5 reasons as to WHY NOT to trade on High Frequency:
1- If we trade on high frequency with an amount less than a million or something, we could get killed by the spread and commision fees we would have to pay per transaction
2- We most likely don’t have access to gigantic powerful computers
3- We are probably not algorithmic computer programmers who do this as a full time job and therefore it is unlikely that we can outsmart the large firms trading on our fancy smart phones
4- Even if we are computer programmers, we know that a single bug in our coding can ruin our whole capital
5- We trade to invest long term and high frequency trading wouldn’t allow us the time to carefully analyse our capital and the market movements.
On a side note, if you ARE a coder with an amazing algorithm and would like to trade $1m per day, you could definitely negotiate with your broker for tighter spreads and better rates.
Now I want to hear from you. What are your thoughts on High Frequency Trading? Do you know someone who does it and is successful at it? Would you like to become a high frequency trader? Join the conversation on our Facebook page, Twitter, Google+ or Linkedin at Invest Diva.