Today, we’ll discuss how high-frequency traders (HFT) consistently make money in the financial markets.
Let’s delve into the logical and systematic principles of HFT active trading, which are the foundation for these types of traders:
- It is impossible to predict the future.
This is a fundamental property. Therefore, predicting future events based on past events is a futile endeavor. When applied to trading, this means that any conclusions based, for example, on the historical price chart have no practical value. Consequently, tech analysis will not work over a long period. Why is there a period in the history of trading when people were earning for years on all these technical indicators? - Future events can be organized into several significant (in the sense of influence on profit) outcomes, each with a certain statistical probability.
Is there no contradiction with the previous point here? In this case, we are not trying to predict anything but to clearly define probabilities and plan our actions according to their value. The problem here is that it is quite difficolt to calcolate these values because there is the influence of many factors that must be taken into account in determining the probabilities. The number of these factors is constantly growing with the growing popolarity of trading, the acceleration of technical progress, the appearance of new tools, etc. - The correct calcolation of probabilities of outcomes is possible only in short time intervals.
This conclusion follows a simple logic: the longer the time horizon of calcolations, the more factors must be considered. For example, news events undoubtedly strongly influence the balance of supply and demand in the market. It is rather difficolt to consider them in mathematical formolas due to the random nature of this factor itself. However, on a time interval of, say, 5 minutes, this influence is orders of magnitude less than on an interval of 24 hours.
There is nothing new in these principles, in general, they are the basics of probability theory. Nevertheless, many traders, for some reason, persistently ignore this theory. In the 70’s – 80’s in the USA, market participants were quite successful in making money on the market, applying technical analysis, for the simple reason that the factors that have a significant impact on the market were many times less than now (including because of the smaller number of counterparties). Technical analysis indicators more or less reflected statistical dependencies that existed in historical prices, volumes, etc.
Nowadays, it is obvious that these sources are insufficient. However, even now, it is possible to find periods in the market where some technical indicators seem to give correct predictions. However, such periods have shorter and shorter durations, and, undoubtedly, in the long term, trading based on tech analysis will have a random character with negative profitability (due to commissions and slippages).
So, for profitable trading, you need to apply the probability theory correctly on small time intervals. If the calculations are correct, the profitability of your strategies will be many times, if not dozens of times, higher than traditional investment and position trading strategies. And the quality of equity will be better by orders of magnitude. For example, here is a chart of daily profit of one copy of a high-frequency trader’s strategy (the black line is a test, the red line is real). The daily profitability here is about 50%! The number of profitable trades is 53%, the number of losing trades (together with zero trades) is 47%, and the average profit/loss ratio is 1.05.
That is, with such a seemingly insignificant advantage in calculating probabilities, the result is very significant – the effect of numerous trades, i.e., a sufficient statistical sample even within one day.
Unfortunately, it will not be possible to top the Forbes list, even with such profitability, as significant limitations exist:
- All active, especially high-frequency strategies, do not allow the use of significant capital due to limited instant liquidity.
- Because of the requirement to react quickly to market events, the software is complex and needs constant adjustment to changing technology.
- Competition is continuously increasing, which entails a steady decrease in the profitability of algorithms.
Hence, there is a need for continuous strategizing and searching for new markets and tools worldwide.
To ensure all of the above conditions, trading cannot be a hobby that you only turn to occasionally. Trading has to become your job, which is likely one of the most challenging jobs you will ever do. So the rule of thumb is that you have to enjoy it. And in this case, trading will bring you a stable income.
