EDUCATION – How HFT and program trading are relevant to my trading method and can be in yours – Part 2

You should know by now that HFT and program trading is everywhere. In the first part of this series of articles on HTF and program trading I explained what HFT and program trading are and how they can affect the market. They however offer an excellent trading edge, as well, which can be used in our trading. The decisions taken through the application of rules identified by observing the effect of program trading on price are often in contrast or well in advance of the observations and signals offered by classical Technical Analysis (TA). Typically these decisions will go against what the crowd is thinking too and this fact alone is important because it is suggests that following program trading is the right way to approach the markets (or at least it is right for me).

Computer programs, indeed, do not have an emotional component. They continuously repeat their instructions and follow rules always the same way at each price setup and target or at each setup failure’s event and in every timeframe. This can be seen from the type of participation that can be witnessed on the tape (for instance when trading the S&P500) when price approaches specific levels. Programs also take profits regularly at some specific levels and, after a trend failure, fake out moves in the same direction of the failed trend often stop in known area where profit taking and participation in the opposite direction starts with a precision, violence and coordination that can only be explained with the action of computerized algorithms.  When programs are present and active — and there are days of the week and times of the day in which they are not — price behavior is largely based on cause and effect and can be modified, on lower timeframes (like 15min and 4-hour charts), only by the short-term effect of news breaking in.

Rules followed by computer programs are always the same and decisions are based on price levels even if news bring in a temporary modification in market structure and, let me repeat, only on the smaller timeframes.  Contrary to what a lot of participants and professional do believe, news only complete the technical patterns and measured moves already in place. Only a strong participation from central banks can break the technical patterns in place and that, of course, cannot and does not happen often. Computer programs and traders group psychology are responsible for trends and price direction: when the next setup in a sequence of a measured moves fails , that is signalling a new trend in the opposite direction. In order to establish when a trend fails and a new opposite trend is born it is important to know the rules used by programs to the accuracy required. Programs will trade a trend until it comes to an end, and then they will start trading the new trend in the opposite direction. Programs exist on different timeframes from the weekly timeframe down to the hourly, 15min, 5min, 1m and even tick chart. The interaction between trends and measured moves taking place in the different timeframes generates price behavior that can often be foretold, once rules used by program trading are identified.

Trading rules were born and improved upon from the analysis and observation of price subdued to the actions provoked by human emotions and that have the effects of dynamically altering the balance between demand and offer. Such rules became very efficient with time and, with continuous rising of computer-based trading in the stocks and derivative markets and increased volumes, they bring about price behavior that materializes in a truly self-fulfilling prophecy. This is what happens on the markets today and is somehow similar to what happens when price approaches some important moving average (like the 50-day or the 200-day moving averages), there is always some sort of reaction. When, for instance , measured moves are applied backwards to price data going back to the last 100 years (for instance using Dow Jones end of day data) it is disconcerting how the related trade setups work and offer valid entry areas. This is a very significant fact because it shows that the logic of programs, which was initially derived from the study of the psychological response of traders group to price dynamics, evolved in a direction that correctly managed money, risks and profits but taking such important psychological aspect into account, as well. Moreover it shows that the basic rules implemented by computer algorithms worked before computer technology was even invented.

The effect of the ever-increasing presence of program trading in the markets, the high participation and increasing volume in Forex and commodities, an ever-increasing number of professional and retail traders, which can exploit the different ways now available to trade (for instance,Forex crosses can now be traded with mini-futures, micro-futures, variable forex accounts and trade size, cash, etc.) have the combined effect to increase volume more and more. In fact, results of technical analysis, trades signals and setups derived from the observation of the effects of program trading ,work better when the market participation is high, i.e. when volume is high. In such conditions, some markets show a much more technical and predictable behavior and patterns, than they ever had in the past. With ‘technical behavior’ I mean that price responds very well to measured moves and program trading rules. This is especially true for some hedging instruments trading very high volume, like the Euro-Dollar cross and the US indices, and on the most traded Forex crosses, as well. From this viewpoint there was never a better opportunity and today we, retails traders, have the possibility for profiting in these markets as the big boys do. 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 28th 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.

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Filed under Articles, Education, English language, High Frequency Trading, Program Trading, Trading Method

5 responses to “EDUCATION – How HFT and program trading are relevant to my trading method and can be in yours – Part 2

  1. Very good analysis. Do you believe today’s trading was one of those exceptions?

    • Hey Rod, I often say that when levels like these fail there could be some fundamental changes arising. In our case it could be the Euro zone participating to the currency war. While the reason is not important, I have to take note of the break and trade with this new information.

      We may have temporary support at the 1.3360 area but I don’t trust it, won’t trade long after it. If price bounces from that area I would need to see the 1.3584 level violated on the upside before trusting it, and it could be too late. I am more prone to consider support at 1.3200.

      Now there are two important cases that must be considered and they will be reflected in the next video.


  2. simply put – fabulous article. Nice work sir.

    • Hello Fibus,
      thanks for stopping by and reading it.
      Please feel free to share this work on social media: if you found it interesting and useful, I am sure others can too.
      Thank you

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