Some newletter subscribers and people I interact with on the social networks, as well as, in real life frequently ask me how High Frequency Trading (HFT) and computer algorithms trading the markets (program trading) can be exploited in trading. First of all what is HFT all about? A simple definition for High Frequency Trading is a practice that attempts to gain an advantage on the smallest differences in price which can be exploited with high speed trading execution — in the order of milliseconds — using computer hardware infrastructure directly linked to the markets (e.g. AMEX, NYSE, NASDAQ, CME, ect.). To get an idea of what these programs can do, and their effects, please read my article “HFT and program trading is everywhere“.
However there are also programs and algorithms which are less disruptive, yet not less important, as they keep a firm grasp on some markets, not to say that they actually ‘run’ those markets. Seems incredible or not realistic? Well, think again, and observe price: proof is in its behavior. Indeed, on certain markets these programs run on all timeframes, from weekly down to the TICK chart, and their presence is so pervasive that they often play one another on different and even the same timeframes, following exactly the same rules. Why would that be?
Probably some of the reasons are:
- the future is unknown and trading against the current, established trend could mean being in a great position should a change in trend take place;
- the creators of such programs devised a way to trade the markets, constantly taking partial profits out while keeping runners in case of continuation into a larger move in the targeted timeframe, as well as, in the larger timeframe just above it;
- programs take profits while respecting and leveraging on group psychology of market traders (if you want to get an idea of such psychology read my article The Bandwagon Theory, which applies equally to intraday, swing trading and investing);
- by removing emotions, programs also gather an additional edge that only highly disciplined discretionary traders have.
I personally have no doubts of the presence of program trading acting on financial instruments used for hedging like the forex futures, the indices e-minis, gold, 30-year bonds and a few other instruments, and this presence and the effects of it form the basis of my trading method.
These algorithms base their logic on the common psychology of traders, who often buy the long green or white candlesticks, when they should be selling them, and sell the long red or black candlesticks, when they should be buying them. But you don’t have to take my words for granted and I invite you to verify the information. Data reported by studies in the financial markets industry says that an amount ranging from 60% to 90% of trade volume (some analysts mention higher percentages, up to 94%!) is generated by transactions on futures contracts and most US stocks executed through computerized algorithms.
While these numbers are certainly controversial and are continuously subject to research and discussion, the actual numbers are not very important because the proof that automated algorithms exist and participate at specific price levels, well identifiable in advance on several timeframes, is in the behavior of price itself.
Those who follow my market’s video reviews know that I regularly identify in advance valid support and resistance levels, along with current trend failure threshold levels, only analyzing price with the rules observed by studying the effects of program trading. I cannot say my rules are exactly the same of program trading, but they ‘explain’ price very well and that should be enough for any trader; and for sure it is for me.
Every single day, by those rules, it is possible to observe price reacting and bouncing off specific levels that can be identified with hours and, often, days in advance. Moreover, after reacting to these levels, price often gets to specific target levels where profits are systematically taken out of the table. These target levels too can be identified in advance and are strictly related to the same areas where price initially got participation and reversed. Professional traders and automated computer algorithms (program trading) regularly take profits off the market at these levels. Again, proof is indeed in price behavior.
As a certified technical analyst, but especially as a student of the market and trader myself I am sure of the existence of algorithms working on some futures contract, including the Euro-dollar FX currency futures contract that I follow closely. The rules I use also work on several US and European stocks and, generally, work well on highly exchanged stocks: clearly the key is participation and high volume.
The trading rules were identified based on observations of price patterns that repeat on different timeframes, thanks to the painstakingly action of program trading and repeated behavior of traders’ groups, sharing the same psychology. Understanding and learning such rules allowed me to create a reference framework in which market moves make sense. The decisions taken through the application of these rule, along with the related anticipated changes in price direction, often not foreseen (in time) by classical Technical Analysis (TA), go against what the crowd is thinking of doing, and then commonly does. This fact comforts me that the approach I use is the right way to approach the markets (or at least it is right for me).
Will you walk the traditional path of learning to use classical TA, or do you want to discover how learning the rules used by Program Trading can make a difference in your trading? Your choice.
This article appeared on my free Newsletter sent out last Sunday, October the 21st along with other information: typically including a weekly review for the Euro-Dollar cross and other forex, indices or commodities futures, articles on my trading method, market commentaries and HFT/Program Trading articles like the one you just read. Please, register here to receive the free weekly newsletter, to read the following parts of this article.
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