HIGH FREQUENCY TRADING – THE HIDDEN DANGERS OF SCALPING & DAY TRADING

When people first develop an interest in becoming a Forex trader, the main strategies constantly pushed by most other traders are the high frequency trading systems. It’s such a “hot”, controversial, heavily discussed and somewhat viral subject that is saturating threads in all the Forex trading forums. Even the internet marketers and brokers are promoting high frequency trading on every corner of the internet.

High frequency trading approaches, like scalping or daytrading, are no doubt in high demand. Traders are attracted to fast paced systems because they promote plenty of adrenaline fuelled action, immediate gratification and promise of lots of trading opportunities.

If you’re thinking about taking on a high frequency trading system, do yourself a big favour and read this article before you do. The intensity of these systems can turn you into a vegetable, negatively impact your everyday life and maybe even cause you to contemplate suicide. I am going to tell you why I think scalping, or any other high frequency trading strategy is not only a dangerous play, but bad for your health.

The whole idea of high frequency trading is to open positions for only a very short amount of time, sometimes only even seconds. This intense in-and-out trading is the ‘excitement’ fresh new traders are looking for. Even if they are lucky to only walk away with breadcrumbs, it’s still a hell of a thrill ride. You can remember when you first started trading. All you wanted to do was sit in front of the charts all day and take as many trades as you could.

High frequency trading systems generally have very small profit targets. Making decent returns for the day requires the high frequency trader to make a disturbing amount of profitable trades to ensure their efforts are worth it. But at this stage who cares right? They’re trading. They’re happy riding high on endorphins. Nothing else matters! It’s an addiction to drugs. These guys know it’s detrimental to their quality of life, but they still chase the high.

Eventually the whole initial buzz wears off. The trader starts getting serious by focusing more on actually earning money. Unfortunately the trader is still ‘conditioned’ to that high frequency trading mentality. It can be a vicious cycle to break free from because no one likes to admit defeat. The truth is that the high frequency trading approach to the market doesn’t work. Sooner or later, traders engaging in high frequency trading strategies will realize they’re flogging a dead horse.

High frequency trading, particularly scalping, requires you to spend many hours glued to monitors tracking the minute by minute movement. If you go for a toilet break, or the kitchen to grab a coffee/something to eat, you may miss out on the trading opportunity you’ve been staring at the charts for the last 3 hours waiting for. #frustrating

Sitting in front of the charts for too long is mentally taxing and even will affect you physically. Personally, I’ve had enough after looking at charts for more than 30 minutes. The thought of spending extended in front of them, keeping track of minute price movements non-stop, makes me uneasy.

Your mind can only take so much. How long can you sit in front of charts and remain mentally focused? How long before you get tired and start making bad trading decisions? What is the threshold where boredom kicks in and you start forcing trades just to make something happen? Trades should only be opened when the probabilities are in your favor, not because you need mental stimulation.

Most high frequency trading systems encourage bad money management by expose your account to an unhealthy amount of risk. Generally, a high frequency trading system requires you to risk too much for the small gains. The risk reward ratios are usually in the negative, a serious red flag in my books.

The losses are so much bigger than the wins. One losing trade can put you in a deep hole that’s very hard to climb out of. High frequency trading rule always seem to focus on pips. I’ll show the same courtesy with the following example.

A high frequency trader might risk 20 pips to gain 5 pips. That’s a negative risk/reward ratio of 4:1. To put that in perspective, one losing trade will set a scalper back 4 risk factors. The scalper’s next 4 trades will need to be successful in order to get the account back to the ‘break even’ stage. Of course that’s assuming the same lot sizing is used on all the trades. High frequency traders tend to use irregular money management.

High frequency trading can go pear shaped so fast, it’s frightening. The chances of the next 4 trades being successful are against you. The margin of error allowed is 20 pips. That’s not much at all considering the average day to day volatility is three times greater than that. The market only needs to hiccup in the wrong direction and the trade is stopped out. While the high frequency trader is trying to recover from losses, every single stop out makes the hole 4 risk factors deeper.

Negative risk/reward means you need to make an overwhelming amount of winning trades over losing trades. Suffering a loss at any time it’s such a huge setback. The desperation and pressure builds immensely when high frequency trading strategies push accounts ‘into the red’. This starts to induce stress which grows into emotional and irrational fueled Forex trading mistakes.

No high frequency trading system, or any trading system in my opinion is going to work out in the long run unless therisk/reward ratios are in the positive. If you’re risking 20 pips, then you should be at least aiming for 40 pips in returns, not 5. A positive risk/reward model of 1:2 allows you to lose half of your trades, but still make money in the long term. That’s why we are adamant about using positive risk/reward in our price action trading because you can’t win every trade, and no one expects you to. It’s so critical to ensure your winners outperform all your losses.

Up to this point we’ve been assuming that high frequency trading strategies actually use a stop loss. I know most of them don’t. Because the stops generally required are so tight, any tiny vibrations in the market will knock out the trade.

These vibrations are just the result of all the normal day to day activity in the market. The larger commercial businesses perform large overseas currency transactions that contribute to the day to day volatility. I’ve noticed most high frequency traders will blame these ‘abnormal’ intraday price movements on their broker trying to ‘stop hunt’ their trade. So to beat the market and their broker, they don’t set one.

We are huge believers of stop losses here. We never place a trade without one. With no stop loss, your account is effectively 100% exposed. I know most high frequency traders are running on the highest leverage possible. The high leverage is abused and high frequency traders over position for their account size. One unexpected news releases could drive the account into a margin call.

Having no stop loss means you have to sit at the screen, monitor your trade, and manually close it. High frequency trading approaches run the trader into a risk of getting caught up in re-quote errors when the market is experiencing increased volatility. Have you ever tried to exit a trade during intense periods of volatility? It’s not a position you want to put yourself in.

Sitting and staring at price charts is not healthy, and is going give you anxiety issues. Using no stop loss is not smart trading. I can’t think of any real advantages of not using one. Your stop loss should be placed at a point if which price crosses, the trade is considered a failure and you no longer should be in the trade.

High frequency trading systems are very emotional fuelled ventures and attract those looking for a massive adrenaline rush. Short term traders can be so disconnected from discipline. Even to the point where most of their trading decisions are just based off‘gut-instinct’.

With each position opened, there is a lot at stake for such minute profits. High frequency trading methods can put a high level of importance on each trade. Traders become highly fixated to the success of one position. Why? Because a loss is too much of a hit to take. I’ve seen high frequency traders who hold positions open at -100 pips. Mostly because they are stubborn, won’t admit they’re wrong, but the main reasoning is because they are waiting for the market to turn around and hit their 5 pip profit target.

When the trade is finally closed off, guess what comes next? The revenge trade, which never ends well. The constant chasing of price, running high on emotions gives a trader a mind-set they’re ‘fighting the markets’.

It’s common knowledge that emotions and trading create quite a dangerous cocktail. You’re not doing yourself any favors by using a high frequency trading system that can easily power up these emotions to destructive levels.

The market takes no prisoners. When a trader breaks under pressure and shows their emotional cards. The market will exploit these emotions and play them against the trader. The only thing consistent between losing traders is emotional pain, so why using a trading system that makes a trader susceptible to such risks?

High frequency trading is one of the most demanding of all the trading styles. Most traders are unhappy with the amount of money they are making compared with the unlimited money making money potential of the market. So they believe they can remedy this problem by trading as much as they can. This is where an attraction to high frequency trading strategies is born.

Overtrading is a massive problem for short term traders. If they’re already opening and closing trades at high frequency, what’s another trade or two, what’s another 20? This encourages the gambling mindset when the trader is no longer thinking probabilities, but trading purely from greed, boredom, desperation or overconfidence. Your attitude towards the market is going to define you as a trader. You think you’re chasing money, but in reality, the only thing you’re chasing is your own tail.

Most short term – high frequency trading system templates I’ve seen are quite heavy on the indicators. Quite a few of them actually require you to monitor multiple time frames at once. I know those images of multiple trading screens, flashingForex indicators and rolling price feeds looks exciting to the new trader, but it’s far from practical when it comes to your trading performance.

More data, or more analysis will NOT create more of an ‘edge’ for you in the markets. In fact, it will do quite the opposite. All the extra variables you bring onto your charts are only going to make it harder for you to execute clear minded, logical trading decisions. Most of the time, the extra variables you do bring onto the charts will often conflict with one another. You’re creating your own trading environment nightmare.

This is why we are such big fans of trading with price action on naked price charts. The clarity you get in un matched with any other trading system, and that’s why it is the most successful trading methodology in this industry.

There is one winner out of all this, and that’s your broker. Brokers advantage from high frequency trading so much, they will even encourage you to do it. Brokers earn spreads on each trade you place, regardless if it’s a winner or a loser. The sad thing really here is, the broker will sometimes earn twice the amount from a trades than the high frequency trader does. Swing traders like us War Room Traders don’t have to worry about spread. Even an expensive spread like 10 pips is not going to effect a trade much that has an expected return of 150 pips.

Despite what you read in the trading forums, high frequency trading does by any definition offer the means to a smooth, risk free path to greater profits. It’s very demanding mentally and physically, takes up large amounts of your time and can have a negative impact your life. In our article: do 95% of traders lose money?, we show evidence that the majority or losing traders are in fact the traders using high frequency trading strategies.

If you’re sick of being bombarded with the false promises high frequency trading systems make. Or maybe you have commitments, like a full time job which wouldn’t allow you to engage in high frequency trading anyway, then you should take a serious look into our end of day trading strategies. Swing trading strategies that use price action demand a fraction of the chart time/ They require you to trade much less, generate much larger returns and have much higher rate of success.

Before you start trading with real money make sure you check out our Forex trading checklist. Also remember. Scalping, day trading or any other high frequency strategy may appear as ‘smart investing’ but it’s only clever wording that is designed to target your emotions and encourage you to hand over your hard earned money.

I hope today’s article has highlighted the dangers of high frequency trading. If you enjoyed the article please help us spread the word and share the article using the buttons below. I wish you a profitable trading week.