Marginal trade elimination is the key to success.
I wrote briefly about HFT in the last week’s issue of my Nifty Edge newsletter and continued my research into it over the week, stimulated by some interesting discussions with reader Akshay Sahgal of Mumbai.
Even as of today the concentration of the HFT algos is more on execution efficiency rather than directional trading. The profits that HFT adds to the firm is coming more from better execution than from any complex strategy that capture a profitable trading set up and runs it. One of the statistics I read was that the HFT player made an average of $1.92 against an institutional trader and $3.46 against a retail trader (trading on the S&P500 futures). This brings to light another aspect about trading.
The difference between an institutional and retail trader is that the former operates under a certain process driven environment with some amount of discretion while the latter is a freewheeling operative, doing what he ‘feels’ like, most of the time. In contrast, the HFT player is completely process driven with high degree of standardization of all processes and has nil discretion. This says a lot for mechanical trading. The reason for the greater profit margin against a retail trader is because the latter makes many more errors, many of them unnecessary ones while the algo is programed to do nothing outside the process and being a machine, can execute it a million times without deviation.
The moral of the story is that route to success is by reducing the marginal errors that we keep doing as traders. These are mostly founded in our emotions that keep heaving when we are either entering or into or exiting a trade. It is also manifest when we have an inconsistent or even incoherent approach to our trading. With HFT now 25% of the trading in our markets, we have all to become more aware that the person on the other side of our trade could be a machine and that percentage may keep increasing. Granting that they will win the emotional game at any point of time, it is our duty, therefore, to bring our own game under control. This can happen only by adopting a specific method, knowing it in all its avatars, and having the absolute confidence in it to spot for us the opportunity to enter markets favorably.
Unforced errors are the bane of every amateur player on a Tennis circuit. It is the difference between the newbie and the professional. The latter wins the game not only by possessing superior skill but also an ability not to make those silly errors that drain away the points- in the case of the markets, profits. Like Warren Buffet has said, “you only need to do one or two things right to be successful- so long as you have not done too many wrong things!”. He said it in the context of investing and life in general. It is equally true for traders wanting to become better at what they do.
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