Institutional And Retail Algo Trading Compared

Large financial institutions like investment funds and banks have been employing high frequency trading (HFT) across a variety of markets for a number of years. In HFT, software and programs implement sophisticated algorithms (‘algo trading’) that allow these big players to generate, route and execute orders at incredibly high speeds, and to establish and liquidate positions within extremely short time frames that exploit minor discrepancies in stock prices far faster than can be achieved manually.

As to the overall effect of HFT on the market, opinions are divided. A Sterling ‘flash crash’ in October 2016, when the currency plummeted to a 30-year low against the USD on Asian markets, was blamed on an automated HFT system (although human error no doubt played its part), as was a rapid fall in the value of the Swiss Franc against the Euro of about 40% in January 2015, which happened in a matter in minutes. (However, in both instances the market correction was swift and normal trading resumed soon after.)

While there is criticism that the power, speed and ubiquity of the big banks’ HFT software affects the operation of the market to the detriment of the individual retail investor, there are some perceived benefits as well. These include adding liquidity to the market through the sheer volume of trades being executed and ensuring more consistent pricing across different markets, as well as improving the efficiency of the market because rapid rises and falls in prices can be a seen as encompassing all of the most current market information.

So where does this leave the retail trader? What opportunities are there for the individual investor to use algo trading to their advantage?

There are automated trading bots and other software that can be utilised by retail traders. Expert Advisors, for instance, are programmes that enable automated retail trading, and these have the advantage that they can be purchased ‘off-the-shelf’, or someone with coding knowledge can create their own. These automated bots can be used in conjunction with the trading platform, like forex metatrader 4 for example, to establish the market conditions under which a trade is opened or a position closed, based on pre-determined factors established by the user. Although the execution of trades is automated, it nevertheless falls to the trader to establish their own parameters as to when and what sort of trades are made, so it is still essential to know and understand how the market works, and what you are trying to achieve. 

Nevertheless, it should be acknowledged that the software and algorithms employed in the HFT strategies of the industry leaders mean that it’s not a fair fight. It can be argued that the speed of HFT means that institutions are able to take advantage of arbitrage opportunities that are not available to the retail trader, and that investments based on algorithmic trading are not the result of research or understanding about companies and businesses, but rather short-term opportunism in price imbalances, and that this ultimately has a distorting effect on the market.

Be that as it may, it nevertheless remains the case that institutional software and hardware provides significantly faster reactions and responses to changing market conditions, and when operating within the same market, it’s unrealistic to expect market retail auto trading solutions, no matter how good they are, to be able to compete with the algorithmic power and sophistication of the big traders’ HFT.

But at the same time, this does not mean that retail algo trading has no place, nor that there is less profit potential for the day trader in using algo trading when compared to a manual strategy. Within its own niche, there are opportunities for individual investors using automated trading to do well through the use of research algorithms that devise and execute strategies based on a stock’s price and trading pattern. Algo apps also enable the individual investor to make trading decisions more confidently by providing access to and analysis of market data that would normally be beyond the reach of the retail trader. Most have a relatively simple user interface that provides data in real time and in an accessible format, so understanding the data they provide does not require industry knowledge beyond that which an effective retail trader would be expected to possess.  

However, an important prerequisite for the successful implementation of an automated trading strategy is uninterrupted up time in order for the software to be able to execute trades 24/7. Software failures, power outages and unreliable Internet connections are often the biggest barrier to the successful use of retail automated trading software by individuals.

Virtual Private Servers (VPS) are an effective way of ensuring that the retail trader doesn’t suffer as a result of costly downtime, because using one means you can continue to trade even during a loss of power or a computer crash. Setting up a VPS for Forex trading essentially means that you can still maintain connectivity, despite any problems that may be occurring in your immediate environment, and this is essential if you are running Expert Adviser, for instance, as you will need to be in the position of being able to execute trades 24/7. It is also far more efficient to run EAs on a VPS rather than your own PC or laptop, as they can be uploaded quickly and securely, be accessed from any device with a browser, and you can be assured of constant up time.

Ultimately, there is certainly a place for algo trading by retail traders, because of the fact that it enables you to execute trades more quickly than can be done manually, and can help you to maintain a consistent plan and approach. However, their relative power and potency shouldn’t be overestimated against the HFT carried out by the big institutions, and that the solutions that retail algo trading offer will still be technologically inferior in terms of capability when compared to what a major player can achieve.

Author: Jason Williams

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