Why Algorithms Aren’t Your Enemy

06/05/2012 10:40 am EST

Focus: TRADING

Price Headley

Founder and Chief Analyst, BigTrends.com

Don’t be quick to vilify high-frequency trading, cautions Price Headley, who explains how retail traders can avoid competing with the computers and can actually use them to their advantage.

My guest today is Price Headley of BigTrends.com, and we’re talking about high-frequency trading and how it’s really affecting individual traders and their performance.

So Price, everybody worries about high-frequency trading, saying that it’s affecting the market and making it harder to make trades. Do you agree with that?

I don’t. I think it’s actually creating more opportunities because it’s creating more volatility.

The key is you can’t try to trade against that and be a one-minute or 30-second scalper against a lot of these computer algorithms and black boxes. You have to know where your edge is.

For us, it’s typically focusing on, say, a 15-minute chart, or for daytrading or swing trading over three to five days, we’re looking to hourly charts so we’re not getting swung by that moment-by-moment, tick-by-tick noise.

There is a lot of noise that’s being created by the high-frequency trading, but the reality is that it’s creating more opportunities.

If the market were dead flat all the time, none of us would have any opportunities.

A lot of times we look for confirmed uptrends and then you’ll get those little flushes where you get an intraday pullback, and based on our systems, we’ll actually take advantage of that and if the set-up is right, we’ll buy into that weakness for what we call a “retest set-up.”

Once it’s confirmed as an uptrend, those retests actually give you great low-risk entry points because if you’re wrong, you can kick them right back out and keep your risk small, but if you’re right, you can get a great entry point within an evolving uptrend.

The same thing works on the downtrend. In fact, the little bounces on the downtrend are very violent, but they’re actually great opportunities if you’re patient and you’re stalking the trade and waiting for that opportunity, rather than trying to rush in and chase the volatility.

That’s the most important thing is to be patient and wait for your right set-up before you pull the trigger.

So, even with the high-frequency trading happening so quickly, you feel like there is time enough to get in when you see these things happening without having your server located at the bottom of the exchange?

Well, that’s what I’m saying: don’t compete against that and think you can be a 13-second scalper unless you have a lot of resources and have one of those servers right there on the floor with those other guys. They’re spending a lot of money to do that.

Our view is to find another time frame where there’s opportunity and use that while the other people are getting flushed out (on other time frames). Use that to your advantage rather than being reactive; be proactive.

See related: Try These Lesser-Known Time Frames

I believe that because of that volatility, it has shaken some traders up and shaken some traders out, but in fact, the reality is that it’s just one more excuse that people are using as to why they’re not successful.

We still see on our hourly and our daily and even our 15-minute systems that they’re still producing very nice equity curves. You’d think that they would be more volatile and you’d have more drawdown risk. Now, there’s always risk, but the key is how you manage that risk.

I don’t mind putting on a trade and if it doesn’t hold that key level, blowing it right back out quickly. The key is you have to learn that discipline of getting rid of your losers quickly and then when you get a good entry point and you’re right, don’t get rid of your winners too quickly.

That’s the classic motto of trading: cut your losses short and let your winners run.

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