Does High-Frequency Trading Affect Forex Traders?

The short answer to the title of this article is: yes. However, it is not a show-stopper if you understand the rules of the game.

Everyone has seen it on TV documentaries. The large grouper or shark swimming lazily as a host of smaller fish hover nearby waiting to scavenge some crumbs when the big fish feeds. However, if those small pilot fish, they can become part of the meal. When it comes to Forex high-frequency trading (HFT), retail traders become the meal. Indeed, if they choose to participate in high frequency trading, they swim in dangerous waters.

Trading is all about processing information, both in and out. In the 19th century, the famous banker-investor, Baron Rothschild, was asked how he managed to always be invested in the right companies at the right time. His response was: “carrier pigeons.” Indeed, he was able to obtain information quicker and more broadly based than others. Well, that was using 19th century technology. Move ahead to the 20th century. When I was a physical commodity trader, I remember having to place long distance phone calls or even telegrams and having to wait hours for some important trading information. Today’s carrier pigeons are digital and fly near the speed of light.

High-frequency trading strategies are usually extremely short holding periods - sometimes for just seconds. These HFT computers are hooked up directly with the market for receiving instantaneous data streaming, order executions and linked with large bank lines of credit. Transaction fees are negotiated to bare bones and the bid/ask price spread is much tighter than retail traders could ever find. It is seamless, super-fast, and only for the big money players such as institutional and fund traders.

Incoming data is processed, analyzed, and trades are executed by super-fast computers. Believe it or not, these algorithms gather news from thousands of sources, identify keywords, and figure probabilities in microseconds. Even if a retail trader receives the same information at the same time, the HFT computers have already digested the news, chosen a position, executed the trade, and closed out with the mini profits before the retail investor finishes reading that very same information. Behind those algorithms, are some of the top minds in the world — mainly physicists — who specialize in sophisticated new probability models. Indeed, its space age trading with a space age price tag.

Needless to say, it takes a large investment in infrastructure to develop proprietary trading algorithms, super computers, and gaining the access to have them placed close to the action (shortens transaction time). But it is not as sinister as it may sound. We can even go so far as to say that these high-frequency traders are very similar to the market makers and specialists in other exchanges. They provide liquidity and lessen volatility — both good things for all traders, large or small. However, playing with the big fish is not a good idea for the small fry.

So, the best strategy for a retail Forex trader is to stay clear and use a different strategy. To compete where they have an edge or an advantage, retail traders should not try to compete with HFT at their game. Rather, they should play their own game where they have an edge. There are many other strategies the retail investor can use successfully. And do not worry about so called market manipulation as the Forex market is so huge that there are plenty of crumbs for all. No need to take on the super scalpers unless you can afford the infrastructure and bank lines of credit to play their game.

by Mike Baghdady

With thirty five years of professional trading experience-and still trading - Mr. Baghdady is a trader, trainer for major institutional Investment companies and the recipient of many awards. He is known as the foremost expert in price Behavior He is now the principal of TrainingTraders.com and developer of the only Price Behavior proprietary trading software used by many major Investment institutions. For more information, www.trainingtraders.com

If you want to get news of the most recent updates to our guides or anything else related to Forex trading, you can subscribe to our monthly newsletter.