High-frequency trading, or HFT, has graduated from the sole domain of institutions with powerful technology to retail traders trying to emulate their success. The growth of personal computing power, improved trading platforms, and high-speed internet access have put HFT on a level playing field for anyone wanting to try it.
Is Retail HFT Trading with Bots Really Possible? Let’s explore this exciting field and see how traders can exploit it.
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What is HFT Trading with Bots?
While there is no single definition of high-frequency trading, most traders agree that it has the following common attributes:
- A large number of trades. As the term “high-frequency” suggests, HFT is characterized by a large number (i.e., frequency) of trades—often hundreds of trades (yes, hundreds!) in a single trading day or session.
- Short holding periods. High-frequency trades are open for very short periods—seconds or even fractions of a second, and at most a few minutes.
- Automated algorithmic trading. Computer-based algorithms or rules automate the decision-making process and execution of entering and exiting trades. This has a practical element, as it is nearly impossible for humans to enter and exit trades effectively in seconds or fractions of a second.
For this article, I will use the above three characteristics (large number of trades, short holding period, and automated execution) to define high-frequency trading. Within this framework, I can simplify the definition to: “automated trading on small time frames.”
In this article, I will focus on the retail side of high-frequency trading. If you are interested in the institutional side, the book Flash Boys by Michael Lewis (who also wrote The Big Short and Moneyball, both of which became movies) is a well-researched and engaging explanation.
The differences between Manual Trading & HFT Bot Trading
There are two key differences between manual trading and HFT bot trading:
- Manual trading means the trader must physically enter and exit each trade. HFT bot trading automatically enters and exits trades. Manual trading can be time-consuming and require lots of screen time, depending on the trading strategy.
- Manual trading can be discretionary or systematic (rules-based). HFT bot trading is always systematic.
Discretionary trading means the trader relies on their judgement (or discretion) when making trades. For example, I am discretionary-trading when deciding whether the price is making a chart pattern formation. Discretionary trading has room for interpretation and is subjective—two traders looking for the same pattern may see the chart differently or enter at different levels. In contrast, systematic trading relies on objective rules without room for interpretation. Two traders following the same systematic strategies should have identical entries and exits.
HFT Trading with Bots—Strategies & Tips
- A complete trading bot must have three parts: entry, stop-loss, and take-profit rules.
An algorithm must cover all three areas to be genuinely a bot. Otherwise, there will be an element of manual entry.
- Common HFT strategies include:
- Market Making: buying and selling on both sides of the market.
- Statistical arbitrage: Using algorithms to identify mispricing or market inefficiencies.
- News-based trading: Using algorithms to analyze news and market data that can potentially move the price and trading on it instantly.
- Momentum or technical trading: Having an algorithm identify and trade technical patterns.
- Momentum and scalping strategies are the most accessible for retail HFT traders.
Scalping is very similar to high-frequency trading, and if you feel you have the skills to program a profitable scalping strategy into a bot, it is an excellent place to start. In contrast, using HFT for market-making, statistical arbitrage, and news-based trading requires technology such as fibre optic connections to exchanges, which is not available to most retail traders.
- After back-testing, forward-test in real-time.
A bias with back-tested strategies is that they can fit past data perfectly (known as “curve-fitting”) but do not work in real-time. To prevent that issue, forward-test the strategy in real-time to ensure it produces results similar to backtesting.
- Test an HFT bot with a small live account for realistic fills.
Demo accounts have perfect fills without slippage or liquidity issues. High-frequency trading results with real money are more sensitive to the broker’s fills than longer-term trading. If I were a swing trader aiming for 100 pips profit per trade, a difference of 0.5 pips of negative slippage per trade is insignificant. However, if I were trading an HFT strategy capturing 50 trades daily, a 0.5 pip negative difference in fills means 25 pips less every day in profits. This could mean the difference between a winning and losing strategy. Testing on a small live account will show whether an HFT strategy works in actual market conditions.
- Direct Market Access accounts vs. Market Maker accounts can yield different results when trading on smaller timeframes.
Direct Market Access (or Non-Dealing Desk) accounts pass orders directly to their liquidity providers. Market Maker accounts fill trades internally using a Dealing Desk. The price fluctuations between the two account types significantly differ on small timeframes. Many HFT traders prefer Direct Market Access accounts (such as ECN and STP accounts) for several reasons:
- DMA accounts show every tiny fluctuation in price movement in the underlying market, which is advantageous for HFT bots trying to capitalize on small price moves.
- DMA accounts often have lower costs with variable spreads that can sometimes be 0 pips. Because HFT means placing a large number of trades, smaller spreads greatly help profitability.
- Consider purchasing a bot rather than building one yourself.
Bot trading has a vibrant community, with programmers offering to sell or rent HFT trading bots. MetaTrader Expert Advisors (EAs) are today’s most widely available bots for retail traders. When I last checked, MetaTrader’s marketplace for bots had 1,700 bots available. The best high-frequency trading platforms will all have their communities offering bots from other traders.
- Turn off the HFT trading bot in market conditions that do not suit the strategy.
For example, some automated strategies are not good around news big news announcements because of slippage and large spreads. It’s easy to turn off the HFT trading bot around these events or switch markets.
Retail HFT Trading—Pros & Cons
Pros
- HFT trading bots can automatically produce a large number of trades, which would be difficult or impossible to do manually.
- One of the biggest obstacles traders face is emotional discipline and taking trades according to their strategy. Automated trading removes the need for constant discipline.
- High-frequency trading can shorten losing streaks. For example, if I were a swing trader and suffered 4 losses in a row, it may take me weeks or months to reach breakeven. However, if I take dozens of trades daily, I could make up my losses that day or that week.
- Hundreds of HFT trading bots are available for purchase or rent from MetaTrader’s marketplace and many more from other sources. MetaTrader’s marketplace is one of the reasons automated Forex trading has become so popular.
- I do not need to be at the screen all the time while a trading bot is running because it automates the entries and exits. In comparison, manually trading a large number of trades requires physical presence at a screen to execute trades, and it may not be suitable depending on someone’s lifestyle (e.g. if they have another job or their time zone). When I moved to Canada from the UK, I found it nearly impossible to manually trade the London Open because it was 3 a.m. local time.
Cons
- HFT aims to capture very small movements, and there is a fine line between profit and loss.
- High-frequency trading is very dependent on broker spreads and slippage.
- Many HFT trading bots I have seen have low reward/risk ratios, sometimes as low as risking $10 for every $1 of profit. These types of bots rely on high win rates to make money, but a small number of losses can damage the account significantly. (I want to stress that not all HFT trading bots have low reward/risk ratios.)
Bottom Line
High-frequency trading bots allow retail traders to access a style of trading that can generate profits on a day-to-day basis without having to sit at a screen all day. There has been a huge development in this area, with hundreds of HFT trading bots available to buy or rent from sources like MetaTrader. High-frequency trading is essentially automated scalping, which means taking small bites out of the market multiple times a day to generate profits. The broker fills and spreads must be excellent, as poor fills across a high number of trades can significantly damage profitability.
