Over the next two newsletters I am going to explore the topic of frequency in trading; why finding a high frequency style of trading is important and why most retail traders don’t adopt this approach.
High Frequency Trading
Hear the term High Frequency Trading and most people will conjure up images of computers, algorithms and the like. Indeed the acronym HFT does indeed refer to trading using algorithms and high speed data. But I would suggest that any trading style that can generate dozens of trades a session should be considered as high frequency, especially when compared to how most retail traders trade.
For those wanting to transition to a more professional way of trading, seeking out a higher frequency style will likely be an important step. It is no accident that HFTs are operated by professional traders nor that many hedge funds embrace higher frequency forms of trading such as market making retail order flow.
Benefits of High Frequency Trading
So what are the benefits of trading in a higher frequency manner? There are actually many and they can be crucial if you are to enjoy a sustainable career as a trader. Let’s look at a few.
Quicker Learning Process
In my recent interview with Aaron Korbs (here) I mentioned how a key factor behind my fast improvement as a trader and ability to learn quickly was that when I started trading I was trading 100+ times a day. This would equate to over 500 trades a week, 2,000 trades a month or 24,000 trades per year (in fact I think the exact number in my first year was significantly more than this). Compare this to an average retail trader (perhaps a swing trader or typical technical analysis style trader) who might trade two-five times a day (some less) or perhaps 500 trades per year. My first year as a trader was equivalent to nearly 50 years of experience in terms of number of trades for a retail trader.
If every trade is an opportunity to learn, I had significantly more opportunities than those who use traditional retail techniques. This has to have been an advantage.
10,000 Trades
Many of you will be familiar with the idea of 10,000 hours of practice being required to achieve mastery of a field. This concept was first discovered by Anders Ericsson and associates and was made famous by Malcolm Gladwell in Outliers. I should add here that 10,000 hours was an average and the actual amount could vary depending on the activity.
As I suggested to Aaron in my interview, with trading I do not think that the number of hours is the important point, rather the number of trades is what counts. If you stare at a screen for 4 hours and place one trade you can still really only learn from the one trade.
Interestingly while researching football (soccer) coaching I read that in Holland, many coaches believe that players should achieve 10,000 touches rather than number of hours practicing or playing. In a game of 90 minutes for example a player might touch the ball 40 times so he doesn’t really have many learning opportunities.
If 10,000 trades were the benchmark for having the opportunity to become proficient as a trader (and that number assumes the trader practiced purposefully and learned from mistakes) then most retail traders will never achieve this mark. Only those employing higher frequency methods will get there.
Get off the Roller-coaster
Higher frequency trading styles will almost always involve trading for shorter time-frames and therefore for smaller profits (and losses). The Norden Method for example, looks for trades of just a few seconds (or less) and just a couple of ticks. Retail traders often can’t see the benefits of this so let me explain this further.
Firstly, with such small P&L swings, each trade is not on its own, of particular importance to us. Our daily, weekly, monthly and yearly P&L will not be too affected by one small trade. Therefore, we should not become anxious or excited by any of our trades.
If we have a loss, it might be a couple of ticks (maybe $25 or so); not something that should affect us too greatly psychologically. If we have two or three losses in a row, it still may not be a significant amount.
Compare that to a trader who trades once or twice a day and say loses $500 on a trade. That will significantly impact that day’s P&L and if he has two or three losses in a row, potentially a fair chunk of the trader’s account may have been lost. Psychologically, the trader may now be in a tough place. Note too, how each trade is of significantly more importance to this trader therefore we can expect them to encounter more excitement and anxiousness when they trade (excitement and anxiousness often exhibit similar behaviour - those who have dogs will know!).
So by placing smaller trades we get off the roller-coaster that so many traders encounter. This is a(nother) reason why I am confused when people who claim to be trading psychology experts, use or suggest trading styles that put their clients on the roller-coaster.
If you want a long term career as a trader we need to get off the roller-coaster and placing trades with smaller P&L is a crucial step in that process. We shouldn’t want trading to be exciting and we should try to make each trade a small step in our P&L journey. Compounding small profits has always been a more professional approach to trading.
Additionally, if you choose a method (say swing trading style) that requires or looks for larger moves, ask yourself how many of those moves are there in a normal trading day? What happens if you are not at your desk or don’t get filled when those moves happen or simply if your chosen indicator doesn’t find it?
Compare that to how many two tick moves or similar small moves exit in any given trading day. There are literally thousands of these. Like London tube trains, if you miss one there will be another along in a minute or two. This also, greatly adds to the benefits of high frequency styles that seek out smaller moves.
So having explained some of the benefits of high frequency trading styles, in my next newsletter I will explore why retail traders usually employ low frequency styles.
Keep Grinding
Gary
What about the cost of commissions in such high frequency trading? They surely take big cut when added?
How can you scalp the ES for 1 or 2 ticks these days when the volatility is so high. It's ok in the overnight session I guess, but in market hours, the moves are very fast. Are you just talking about specific markets such as bonds?