Is There Still Room For the Human Day Trader in a World of High Frequency Trading?

Is There Still Room For the Human Day Trader in a World of High Frequency Trading?

This question leads to constant debate. It is a very hot topic at trading conferences, on trading discussion boards and even on television.

There was a period of time not too long ago where it looked like high frequency trading (HFT) would completely eliminate the need for the human day trader. These trading algorithms seemed to be more efficient, faster and cheaper than using humans. It looked like the growth of algos couldn’t be stopped. However, today’s world is a completely different place.

The “flash crash” of May 6, 2010 changed everyone’s view of HFTs. The pre-programmed algorithms couldn’t react fast enough to developing events and just exited the markets, resulting in a massive loss of intra-day liquidity. Even though subsequent investigations of that day show that algos were not the cause of the crash itself, it revealed that many of them just turned off during that time. Although algos have a significant place in today’s market structure, there is still a significant need for the human day trader. There are several reasons why.

First off, many markets and regulators have been shifting rules to favor the human trader. The regulators in such markets as Australia, and Canada have made rules that make it much more difficult for HFT firms to operate. As more markets develop and become electronic, one has to wonder what direction their regulatory landscape will take. Many stock markets have started charging for messages sent to the market or penalizing firms that have a high order sent to trade ratio. In general a human trader has a very low order-to-trade ratio, because they are point and click traders. European regulators have started putting rules in place (that should take effect in a year or so) that are quite obviously anti-HFT. This seems to be a trend with regulators globally. If this trend continues, human traders will be needed to fill the gap.

Second, the human brain can process and model information that a computer just can’t. A case in point is when unexpected news occurs on a stock, even if that stock is traded by a lot of HFT firms. Generally, in unexpected new scenarios, the HFT firms shut of their trading programs. The reason is because for at least that day (maybe even a few more), the stock is not trading in its normal pattern. This means that the HFT’s algorithm (the series of pre-programmed “if X happens, then buy or sell Y” commands) will not hold for that period of time.

Finally, there are always trades that don’t need to be made in a high frequency style of trading. There are tens of thousands of profitable trades a day that occur at different (or longer) time frames than a typical HFT firm is looking at. Stock markets need different traders looking at different time frames to provide an efficient market structure. In fact, it may even be HFT firms on the other side of the trade with the human trader.

The human day trader may not be able to compete with HFT firms at high frequency trading strategies, but that doesn’t mean there isn’t money for them to make. As long as the human day trader has a fast and reliable trading system, he or she will have the potential to make money.

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Photo by Ken Teegarden