Quantum Mechanics and HFT
By Lawrence
Quantum Mechanics sounds like it has nothing to do with High-Frequency Trading (HFT) except the fact that they both have sound bites coming from an alien planet. However, if you examine the concept of HFT closely, you would be surprise that some principles in Quantum Mechanics do apply on HFT.
(Thanks to Kenneth reminding me on this topic the other day when we got a burst of requests to implement bots to trade on extremely small timeframes)
The Uncertainty Principle
In quantum mechanics, there is this famous Uncertainty Principle, that, in laymen’s term, stating the act of measuring the characteristics of some process will affect the outcome or the characteristics of the process.
What does this have to do with trading or HFT?
Think about a very high frequency chart like 2-second or 10-tick chart. Trading models, arb biases, and bid/ask spread opportunities you get from such data series even if they look promising they will still face the issue stated by the Uncertainty Principle.
Simply put, your order of even just 1 contract or say 100 shares injected into the data series would affect the reactions from the other players using a similar level of high resolution data. They will see your orders and your trades will affect them as their orders may not get filled because your orders are there now.
In short, your actions or your participation within the market will modify the behaviour you expected from your historical data analysis, making all those fancy expectations you’ve got invalidated.
But Everyone is Jumping on the HFT Bandwagon
That’s exactly why you, as a retail trader, should not force yourself into the HFT game. It is very exciting at first because you will be able to discover many such trading opportunities and that certainly looks like a gold mine. The problem, however, is stated clearly in last section that all these fancy potentials you see will no long exists or diminish in profitability once you join the fight.
Remember that the HFT space is so crowded that in order to maintain an advantage over your competitors to exploit the same biases, you must keep up in the forefront of technology, order placement access, etc.
How much money you think large scael hedge funds are spending to offend off their competitors?
Do you think you can keep up in a way that enables you to beat these competitors and picking their pockets consistently?
Dealing with HFT Bots
The more bots are built to trade, the easier it is for you to identify trading setups outside of the noisy high resolution arena. Bots are best at emotionless trading and having high precisions in their entry and exit rules. However, when many bots built in a similar way participate in the same market, their aggregated behaviour in various areas from entry, exit, to money management will produce bigger picture recurring patterns that can be identified quite easily.
Exploit these patterns resulted from the consistent behaviours of the bots instead of fighting these bots directly on their home turf. Pick off points instead of ticks off the market you trade.
Do not imitate the bots.
Do what we human are best at – adapt and survive.
