Back in February, the Chicago Mercantile Exchange announced that they are closing the majority of the trading floors. Open outcry, where floor traders in colorful jackets shouted prices of everything from lean hogs to financial instruments, has been waning since electronic trading was introduced in 1992. Given the advancements in technology, this decision wasn’t a huge shocker. The speed at which computer servers can match buyers and sellers has created a new paradigm of efficient markets. However, it’s important for traders to consider the impact this has on their risk management techniques.
So, how can retail traders alter their trading and risk management style for this new electronic world?
The Rule of High-Frequency Trading
Certain trading plays are less effective now that there is no open outcry and the landscape is dominated by the High-Frequency Traders (HFT) in the electronic age.
HFT is trading for which success depends critically on low-latency communications and decision making. High-frequency traders use computers to process electronic data feeds, make trading decisions and convey orders to electronic exchanges over intervals measured in micro- and milliseconds. HFT has grown with the electronic exchanges that enable it. Considering the all-electronic environment, here are some factors to consider:
- Re-think your ideas on stops– You many need to be more dynamic in the way you place them and use a chess-like mentality to think a number of steps ahead.
- Stick to high volume stocks– It is still pretty hard for HFT’s to manipulate the movements of highly liquid stocks like AAPL or MSFT as well as many widely followed ETF’s. Keep in mind that the higher the volume and tighter the spread, the less susceptible a stock is to mechanical machinations.
- Take a longer time frame– HFT’s can only affect price in the short-term. As you go towards longer time frames, like in swing trading, you can almost completely eliminate their influence.
- Get a jump on the markets – To anticipate a trend change, use predictive trading software like VantagePoint Trading Software. The predictive indicators tell you where the market trends are going, unlike lagging indicators which can only tell you where the trends have been and that they’ve already turned and changed direction. To be able to get on board a trend early, you’ve got to be able to anticipate instead of reacting to trend changes.