July 2012

Developing a trading strategy that gives you the results you are looking for is always a challenge but when it works, the rewards are many. It’s no easy task, of course, given the amount of patience, perseverance, and time you have to put into it.

Inevitably, though, there will come a time when that system stops working. It could happen for any number of reasons, and your first reaction may be to try to figure out why it is not working and attempt to modify the system so it can go back to giving you the results it used to. But let’s get realistic about this: It may just be better if you moved on.

You are not alone. This happens not just to the retail trader but even to professional traders who supposedly have complex algorithms behind their trading systems. Yes, those systems can fail too.

In this day and age where algorithmic trading, or high-frequency trading (HFT), makes up about half the trading volume in the equity markets, it’s also gaining popularity in the forex markets. With competition like that, we need to figure out how to survive in the markets. But how?

Apparently, the Norwegians figured it out. It was comforting to hear that traders in Norway discovered how to beat the high-frequency traders at their own game. They found out that every once in a while an algorithm will fail, whether it is by some type of “fat finger” error, a programming bug, or just plain system failure, so when that happens, they discovered they could swoop in to take advantage of that error and make lots of money. So it can happen!

But how can you know when an algorithm has failed? You have to know the characteristics of a specific equity or forex pair to recognize that something unusual is happening. That means you have to constantly watch your screens day in and day out, waiting for that error to occur. How is that for an exciting day at work? It may not be exciting, but given the rise in HFT, it becomes necessary to figure out how we can carve out a niche for ourselves so we too can enjoy the rewards the market can provide.

It is time for us to develop new trading systems that can help us get our edge in these new markets. After all, HFT has replaced the floor trader, so instead of competing against other humans, we are now battling computers who trade in and out of stocks within milliseconds. That’s faster than we can even think. Thriving in an HFT-dominated market is a challenge, but we have seen that it can be done. Forward!

 Jayanthi Gopalakrishnan, Editor

Originally published in the July 2012 issue of Technical Analysis of Stocks & Commodities magazine. All rights reserved. © Copyright 2012, Technical Analysis, Inc.

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