How to Beat the High-Frequency Traders

A Guest Post by FXTM

High-frequency trading is constantly in the financial headlines today, as computers struggle to gain a few microseconds advantage over rival trading platforms. This shift to automated algorithmic trading has fundamentally changed the equity markets and has had a lesser but still substantial effect in Forex markets. This begs the question whether there is any room left for human traders– how can they hope to compete with machines that make thousands of trades per second and never get tired?

However, there are a number of different strategies that traders can adopt to beat the high-frequency machine traders. The first thing to understand is that high-frequency trading requires a market with good liquidity. It is only possible to make large numbers of trades if there are other parties out there to trade with. Therefore, human traders can often avoid automated trading entirely by investing in illiquid areas such as lightly-traded currency pairs or bonds. These areas can be risky – bad news or write-downs can have a sudden and devastating effect. However, transaction costs are relatively low, allowing investors who are patient to generate profits over time.

On the other hand, markets that are very liquid – such as high-volume stocks and common currency pairs – are not attractive for high-frequency traders either. Because the number of transactions is so high, it is very difficult for large institutions to manipulate these markets using algorithmic trading. While they may participate, the playing field for humans and computers is much more level. In fact, investors who combine both low-volume and high-volume markets in their portfolio while diversifying into multiple asset classes have an opportunity to drive profits while lowering risk. The important thing is to avoid the middle ground where high-frequency traders like to play – where there is enough liquidity that they can execute trades but not so much that they can’t influence the market.

The other thing to remember is that computers still are not very good at interpreting all of the nuances of human language. For example, high-frequency trading platforms may scan news headlines to identify opportunities to trade. However, if those headlines are open to misinterpretation, or if they are sarcastic or ironic, then there is a good chance that a computer will misunderstand them. This type of error in interpretation can cause automated trading platforms to take missteps, providing an opportunity for human traders to exploit the mistake.

Finally, it is important for human traders to recognize where they can’t compete with computers. Algorithmic trading platforms never get tired and will take advantage of the slightest slip by a human trader. Therefore, it is important to maintain focus and to avoid trading when fatigued. Traders also benefit by staying in good shape – physical exercise increases stamina, allowing them to make better trades for longer periods of time.