Monday, December 28, 2009

Adapting to High-Frequency Trading Algorithms

Hats off to Mike Bellafiore of SMB Capital who has written one of the few insightful articles I've read on how traders can adapt to the high-frequency trading of algorithmic programs. Mike's firm trades individual stocks and ETFs, using strategies that rely on both technical setups and a reading of order flow. They are active in training traders in those strategies and have seen first hand how the computerized trade has posed challenges for short-term traders.

The key word in Mike's article is "adapt". Setups that might have worked very well in the past become marginal when trade is dominated by the algorithms. Conversely, variations on those setups can become quite successful once one adapts to the high-frequency trade.

If, for example, we know that programs are buying new lows in stocks, we can wait for those bounces before going short, rather than aggressively selling weakness. In other words, you wait for the algorithms to do their thing and then act on opportunity.

As one savvy trader (who has adapted well to changes in the market wrought by high-frequency trading) told me recently: "Programs change the path, not the destination."

It's an important lesson for short-term traders.