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Using High Frequency Trading to Your Advantage

|Includes: Acme Packet, Inc. (APKT)

Michele Schneider
http://mish.marketgauge.com

Not too long ago, the buzz around the street was all about High Frequency Trading Models and the possible legislation that would be enforced to try and quell them. What is High Frequency Trading (HFT)? According to an interview with Sal Arnuk Partner of Themis Trading LLC printed June 14th 2010 in the High Frequency Trading Review—yes, there is such a publication—“I guess you can call HFT any strategy that involves high speed execution of thousands of orders per second, or in a short time period. I don’t even want to handicap it by calling it thousands as some people can do a million.”

According to Wikipedia “In the U.S., high-frequency trading firms represent 2% of the approximately 20,000 firms operating today, but account for 73% of all equity trading volume.”

To date, there has not been legislation passed curtailing firms from HFT and the debate continues. We as traders do not need to participate in that debate, but rather understand that it exists and there are ways to identify when the HFT prints are occurring, thereby adjusting your trading strategy. When I traded as a commodities floor trader, our job, in essence, was to know where the larger resting orders were, run the market up or down to trigger them, and then sell into the rally or buy into the dip. Now that we trade electronically, we know we cannot beat the HFT computers of firms like Goldman Sachs. Therefore, we first learn to identify when prints are occurring that force the market artificially low or high and go against the rhythm and the main trend of any particular stock or index. Then, once you can distinguish when this recurs, you can wait until it reverses thereby taking advantage of these false types of prints.

Here’s a strategy to make out when the HFT algorithms are in play to find good trading opportunities and avoid buying false breakouts/breakdowns.

Step 1

Pick out stocks that are strong. Today’s example, APKT is perfect. It made new highs on June 1st, 2010, and then retreated when the market came under pressure in the subsequent days but remained strong in a bullish phase.

Step 2

Buy weakness in a strong stock on an intraday basis and allow yourself to place really tight stops to reduce risk to virtually the lowest possible risk you can have. In APKT, there were several opportunities to get long. We are showing you the trade on June 17th as APKT came back over the 10 day moving average and consolidated for 4 days. We drew a trend line on the daily chart coming down from the recent high. That was a head’s up that the stock would attract buyers once the trend line was penetrated and more than likely attract HFT buy orders.

Step 3

Once the HFT computers push a strong stock temporarily and artificially low by gunning a key reference point, we like to use the 30 minute Opening Range low. Orders often bunch up at the OR low. If the HFT models can see this, they will trigger the stops underneath that low, clean out the stops, a new low is made and then, we look for the reversal. Basically, what was once the domain of floor traders is now the domain of these HFT computers. Looking at the intraday chart of APKT, on June 17th, it crossed the trend line, took out the previous day high and sold off. It broke the floor trader’s pivot and the 30 min OR low. Sell orders were triggered and within 15 minutes, APKT spiked lower, making a new low (not taking out prior day low) and then bounced back.

APKT Intraday Candle Reversal

Step 4

Look for the reversal using a simple technique with a 5 minute candle stick that has its first positive close back above a key reference point such as a 30 minute OR low. In APKT, I’ve highlighted where the stops got triggered underneath the OR low. We bought APKT once it crossed back over the floor trader pivot and back above the 30 minute OR low. Our stop was now the low of the day. We got long a strong stock, after the HFT finished selling, against a great reference point and with an extremely low risk (around 1/3 of the Average True Range.) Notice how the rest of the day went. APKT proceeded to rally, taking out the trend line and closed on new highs.

If you’ve been searching for a way to make HFT and algorithm trading work for you rather than defeat you, this strategy is highly effective.