Tuesday, February 23, 2016

Avoid Competing with HFTs

With the HFTs ruling the short term trading patterns, you see many more intraday overbought and oversold conditions that are both irrational and deceptive.  What I mean by deceptive is that some of these intraday movements seem like a new breakout or a breakdown from an important price level, but in hindsight, more often than not, they are massive stop runs that marked an intermediate term top or bottom.

For example, on February 11, you saw a massive spike in Treasury prices that ran over a lot of shorts, both with short term and long term trading horizons.  The HFTs can sense these dislocations and can sense when big orders are about to hit the screens, so they front run them, exacerbating the moves.  Since too many pile onto the same side, you get really big moves, which reflexively causes more panic until the moves exhausts itself as the panic exhausts itself and the HFTs close out their positions for fat profits.

There are many predatory algos that specialize in front running institutional order flow in order to make quick short term high probability trades.  Ironically, the best way to prevent them from front running so boldly is to have spoofers fake institutional order flow to get HFTs to overreact to size on the order books.  The spoofers keep the HFTs more cautious when front running.  But now that spoofing is being made illegal, you get front running run amok, leading to days like February 11, when you get  massive short squeezes in Treasury futures which lead the correlation algos to short the S&P and Eurostoxx futures.

It is harder than ever to daytrade this algo driven market, especially for counter trend traders, which is why I have expanded my time frame to more swing trading, with very little daytrading.  Most of my trades now last from 2 days to 2 weeks.  When intraday price patterns were less random, I did a lot more daytrading.  But the algos are so quick to catch on to historical intraday price patterns that they have made past short term trading strategies less effective and lower probability.  The HFTs are going to be much better than you at taking advantage of intraday opportunities.  I don't want to compete in the timeframe where they are the best.  The longer the timeframe, the more favorable it is for perceptive discretionary traders over computer algos.  

Seems like we got overextended and overbought yesterday on the upside, and since this is a weak market, you have a hard time staying overbought, so you get immediate down days.  This did NOT happen in 2013 or 2014 after V bottoms.  Those backtesting strategies to use for this market will be sorely disappointed with the results if they use the last 10 years as their sample size.

I remain of the belief that we will grind higher, but it will not be easy to trade long now.  The up moves will be choppier and there will be out of the blue down days.  Not doing much recently, waiting for easier trades to show up.


shzhning said...

Hi do you ever back test your strategy? or you just have been in the market for so long that you know what works and what does not? It sounds like you're skeptical of any mechanical systems.

I've been trading for quite a while now and I always wanted to do proper back test, but the learning curve is so deep that I basically trade the "trial and error" way. After reading your post, I almost feel like no matter how good your back test is, the changing market will make it irrelevant. What do you think?

Market Owl said...

I don't backtest my strategy because I don't trade a mechanical system. I think the best strategies are discretionary in nature. In fact, Jack Schwager who wrote the Market Wizards series noted that successful discretionary traders had the best Sharpe ratios.

MM111 said...

Damn, missed the 1890's.

Market Owl said...

Still not too late to get in. Very high probability that we get to 1940 again before week is over.

MM111 said...

We are pretty much there. Oh well.