Forum on trading, automated trading systems and testing trading strategies
Sergey Golubev, 2014.04.15 16:57
High Frequency Trading Explained Simply
High frequency trading has been in the news more, thanks in part to
Michael Lewis’ new book, Flash Boys. This article presents a simple
explanation of how and why high frequency trading works, and why it is
good for small investors.
We will begin by imagining a market with lots of small individual
traders. Then we will look at how large institutional investors change
the market. Next we will look at high frequency trading. Finally, we’ll
explain how small investors are impacted.
Start by imagining a stock with no particular news about it. The price
is stable, but there are lot of small trades. Some investors have
enjoyed gains but now think the stock is overpriced. Other investors
have seen gains and have decided to jump on the bandwagon. Some
investors have been watching it, and now have money to invest. Others
have owned it and are happy with the stock but need some cash. So lots
of orders are coming in, pretty evenly mixed between buy and sell
orders. The price trend for the stock looks perfectly steady.
Now consider that the traders are not all small investors. Large
institutional traders are doing the same thing—some buying and some
selling—but there’s a difference between them and individual investors.
When a large mutual fund or pension fund places a buy order, it could be
for a million shares, not a hundred shares. Similarly, sell orders from
institutions come in very large quantities.
Over the course of the day, these large institutional orders cause a
lumpy pattern. The chart shows what such a price line looks like. There
is no noticeable trend up or down, but each institutional order moves
the market up or down, and it takes a while for the price to return to
the underlying trend line. That’s illustrated with the red line in the
High frequency traders try to profit from the price movements caused by
large institutional trades. When a mutual fund sells a million shares of
a stock, the price dips—and HFTs buy on the dip, hoping to be able to
sell the shares a few minutes later at the normal price. When a pension
fund buys two million shares, the HFTs short-sell the stock, hoping to
close their position at a profit. (Short selling is selling stock you
don’t own; you borrow the shares from a stockbroker, sell them, and then
later buy the stock to return the borrowed shares.)
HFTs are buying when the price is below trend and selling when the price
is above trend. This tends to reduce the price fluctuations. When they
are successful, prices look like the blue line on the chart. The blips
are smaller and shorter-lived.
HFT is not as easy as this simple explanation sounds. First, there are
many HFTs. If one is slow, the profit opportunity may have been captured
by other HFTs. Second, not every blip is just a blip. If the stock is
impacted by an downward trend in the overall stock market, the HFT would
buy lots of different stocks—and then watch them all go down further. A
good HFT has to be fast, but not so fast as to get caught be a
surprise. In practice, the HFTs are no longer just looking at just one
stock in isolation. They are looking at all the prices coming in,
including stocks, bonds, commodities, futures and options. This massive
data crunching helps them identify what are likely to be short-term
blips but not long-lasting trends.
In the early days, it was fairly easy. As more companies got into the
business, the easy trades were quickly taken by others. HFTs needed to
move faster and faster, while crunching ever more data to avoid losing
trades. Much of the attention they have received lately is due to their
extreme efforts to reduce their reaction time, which is measured in
milliseconds. This effort is not made to be faster than individual
investors or institutional investors; HFTs are already faster than them.
Instead, the effort is made to be faster than competing HFTs.
Now, how does high frequency trading impact those of us who are small
investors? Look at that chart. If I place a simple buy or sell order, I
may get lucky or unlucky. My buy order may be at a downward blip, but it
may also be at an upward blip. I don’t want to get lucky if it means a
chance of being unlucky; I’d rather trade at that underlying trend
Further, investors face a spread between the price at which they buy
(the “ask” price) and the price at which they sell (the “bid”). This
bid-ask spread compensates the market makers for executing trades at
exactly the time that I want to trade. The more volatile the stock price
usually is, the wider the bid-ask spread. HFTs tend to narrow the
bid-ask spread by protecting the market makers from bad news while they
hold their positions. Thus, my trading costs get lower.
High frequency trading is secretive and mysterious, but not at all evil.
It make the stock market more efficient and helps small investors who
trade at random times over the day. I could almost feel sorry for them
being misunderstood—until considering that they have made far more money
than I have.
AUD/USD Intra-Day Fundamentals: Australian Retail Sales and 17 pips range price movement
2017-02-06 00:30 GMT | [AUD - Retail Sales]
if actual > forecast (or previous one) = good for currency (for AUD in our case)
[AUD - Retail Sales] = Change in the total value of sales at the retail level.==========
From official report:
AUD/USD M5: 17 pips range price movement by Australian Retail Sales news event
EUR/USD Intra-Day Fundamentals: ECB President Draghi Speech and 34 pips range price movement
2017-02-06 14:00 GMT | [EUR - ECB President Draghi Speaks]
[EUR - ECB President Draghi Speaks] = Speech on monetary policy before the European Parliament's Economic and Monetary Affairs Committee, in Brussels.==========
EUR/USD M5: 34 pips range price movement by ECB President Draghi Speech news event
S&P 500 - bullish with key resistance at 2,300 (adapted from the article)
Daily price is located far above 100 SMA/200 SMA reversal area by breaking the high of the last month at 2,300 to above for the bullish trend to be continuing.
AUD/USD Intra-Day Fundamentals: RBA Cash Rate and 36 pips range price movement
2017-02-07 03:30 GMT | [AUD - Cash Rate]
[AUD - Cash Rate] = Interest rate charged on overnight loans between financial intermediaries.==========
AUD/USD M5: 36 pips range price movement by RBA Cash Rate news event
S&P/ASX 200 Index: range price movement by RBA Cash Rate news event
EUR/USD Intra-Day Fundamentals: French Trade Balance and 29 pips range price movement
2017-02-07 07:45 GMT | [EUR - French Trade Balance]
if actual > forecast (or previous one) = good for currency (for EUR in our case)
[EUR - French Trade Balance] = Difference in value between imported and exported goods during the reported month.==========
From rttnews article: French Current Account Deficit Narrows In December
EUR/USD M5: 29 pips range price movement by French Trade Balance news event
USD/CAD Intra-Day Fundamentals: Canada's Trade Balance and 31 pips range price movement
2017-02-07 13:30 GMT | [CAD - Trade Balance]
if actual > forecast (or previous one) = good for currency (for CAD in our case)
[CAD - Trade Balance] = Difference in value between imported and exported goods during the reported month.==========
From official report:
USD/CAD M5: 31 pips range price movement by Canada's Trade Balance news event
Technical Intra-Day Targets for EUR/USD by United Overseas Bank (based on the article)
EUR/USD: ranging waiting for direction.
is located within 100 SMA/200 SMA reversal area and near and above 200 SMA in the ranging area of the chart: the price is testing 1.0655 support level to below for 1.0620 level as the nearest target for the bearish reversal. By the way, UOB is
evaluating the trend for this pair as a neutral with 1.0700/1.0615
"The ease of which the strong 1.0700 support was taken out came as a
surprise (low has been 1.0653). EUR has likely made a short-term top at
1.0825/30 last week and the current pull-back from the high appears to
have room to extend lower towards 1.0615, possibly extending to 1.0575.
At this stage, a sustained move below 1.0575 seems unlikely. Resistance
is at 1.0735 but only a move back above 1.0760 would indicate that the
immediate downward pressure has eased."
RSI indicator is estimating the ranging trend to be continuing in the near future.
Technical Intra-Day Targets for AUD/USD by United Overseas Bank (based on the article)
AUD/USD: bullish to be resumed
is above 100 SMA/200 SMA in the bullish area of the chart: the price broke symmetric triangle pattern to above with 0.7680 resistance level to be broken for the bullish trend to be resumed. By the way, UOB is
evaluating the trend for this pair as a bullish with 0.7700 key resistance level:
"AUD desperately need to ‘punch above’ the major 0.7700 resistance or the
risk of short-term top would increase rapidly. In other words, the
bullish phase that started last Friday may come to a premature end
unless there is a move above 0.7700 within these 1 to 2 days.
Alternatively, a break below 0.7595 would also indicate that a
short-term top is in place."
Brent Crude Oil: 53.56 level for the correction to be continuing; 50.63 level for the bearish reversal to be started (adapted from the article)
Daily price is located above Senkou Spam line which is the virtual border between the primary bearish and the primary bullish trend on the daily chart. The price is started with the secondary correction in the beginning of this month with the support level at 54.59 to be broken to below for the nearest re-enter target at 53.56.
If the price breaks the next target at 50.63 to below so the daily bearish reversal will be started.If the price breaks 57.42 resistance level to above on daily close bar so the bullish trend will be resumed.If not so the price will be on ranging within the levels waiting for direction.