The role of HFT/algorithmic trading in financial markets has been progressively growing since inception, however, many believe that humans still possess certain edges in analyzing data. Given that there are traders who have consistently outperformed the market in spite of these automated systems, it is clear that the benefits of human trading have not been fully exhausted. Despite that fact, algorithms are another form of competition and in fact may consume the financial markets entirely at some point. There is space for new day traders, however, if you want to invest time and money into learning day trading the question becomes whether you are willing to put in the work necessary to work around the algorithms and to recognize when you don’t have an edge.
Pick your spots
In the quest to compete with algorithms, human traders should think carefully about where they can find an advantage and ensure they press that advantage once it’s discovered. For someone just beginning, try a variety of markets and determine where you have the greatest ability to interpret the news and technical patterns relevant to that market. One simple starting point is to trade instruments with lower volume and lower total market capitalization; these markets are generally unattractive to institutional investors using algorithms to deploy large amounts of capital.
Continuously focusing on finding an edge will enable you to use nimbility to your advantage. That is, as a new day trader your relatively small capital pool can be deployed in a single market; algorithmic traders are frequently engaged in many markets and have strict risk parameters which prevent them from participating with the same discretion you can. This lesson translates to all aspects of day trading: you only have to be right frequently enough to make money. More specifically, you only have to be right about a very small subcomponent of a single market to generate meaningful returns as a day trader. Knowing that, progressively compressing your area of focus and becoming an expert in a small subsection of financial markets will help you compete with algorithmic traders.
Fighting the algos
One supposed way to gain an edge over algorithms is to use them as a direct signal. That is, human traders can attempt to identify when algorithms are doing something in the market and trade based on the expected actions of those algorithms. This method is generally difficult and less productive than simply trading the market through practice, due diligence, backtesting, etc. The one instance when such a strategy may be worth pursuing is during extremely abnormal periods like flash crashes.
For those unfamiliar with the term, a flash crash is generally defined as an event in which stop algorithms and stop loss orders create a chain reaction of selling, resulting in a massive downward movement in price over a very short time period. If you believe you are witnessing such an event, as a human, you can recognize that prices will likely recover and buy into the flash crash. Notably, flash crashes are very rare and usually last a matter of minutes, making them very hard to identify and capitalize on. Overall, trying to wage war against algorithms is not a recommended strategy for day traders.
Make technology work for you
Instead of fighting technology, human day traders can use it to their advantage much like algorithmic traders do. After all, you are perfectly capable of engaging with and accessing sophisticated technology which analyzes and backtests massive amounts of data. In that sense, you can use your human capabilities in conjunction with computerized data sets to see things that algorithms cannot. Use software to analyze patterns, backtest strategies, and receive real-time market news. Your ability to interpret this data and instantly narrow down a specific set of strategie is an incredibly powerful tool- don’t let it go to waste.
Engage the news cycle
Interpretation of news is a critical component of the human edge over algorithms. Many algo traders are attempting to correlate certain keywords with price movements, however, a human being can interpret entire news stories and their “true” meaning. To maximize the power of this capacity for interpretation, you should become a news junkie. Read everything that is happening in the market you trade and research the impact of different events. Those who successfully develop this talent will have a true competitive advantage over algorithms as well as traders who only analyze technical patterns.
Can anyone stop the algorithms?
Although algorithms certainly pose a challenge to human traders, there is still space for conventional day trading. Those with the grit, discipline, and emotional stability required to undertake this challenge are likely to generate meaningful returns over time. The same characteristics which made great traders before algorithms can still make great traders after algorithms.