Electronic trading. Wow. Algorithmic trading. Whoa. High-frequency trading. Huh? That's the typical response most beginner day traders have when they learn about these big fish circling the markets, says Warrior Trading's Ross Cameron.
The same technological advancements that birthed day-trading - high-speed internet connections and direct access to the markets - also spawned a whole new range of seemingly scary other types of market participants.
As computers got faster, with shorter processing times, advances in machine learning and artificial intelligence-enabled institutional investors and programming wizards to create complex computer programs - algorithms - to formulate and execute trading strategies without the need for a human to make a decision. As these algos grew in size and smarts, they began learning how to create trading strategies themselves. Soon these algos (and their creators) realized they didn't need to pick stocks with big price swings to make a ton of money. Instead, their algos could identify tiny price moves in stocks with a lot of liquidity, buy in bulk, and create the massive gains they were after. Enter the era of high-frequency trading.
The common day trader doesn't have the programming expertise, resources, or direct market pipe to develop and operate a proprietary algorithm or HFT strategy. Yet they must operate in the same market as these big behemoths. So, they're left at a clear disadvantage in the fight for price movement and liquidity against the algo traders and dark pools.
That may be the conventional wisdom, but Warrior Trading's Ross Cameron doesn't quite see it this way.
Ross Cameron On How To Swim With the Big Fish
"Among the day-trading community, there's a lot of skepticism - almost conspiracy theory - about what these market makers do behind the scenes or they really stop hunting," says Warrior's Cameron. "They see our stop orders on the book. Do they drive the stock down, liquidate all those shares, then bring it back up? Do they have the power to do that?
"I don't know, being on this side of the table as a retail trader. I don't know the inner workings to say with authority how it works, but I certainly understand that they do utilize algorithms."
That being said, Cameron admits he well understands market patterns.
"I also understand that they subscribe to these incredibly rich data feeds and those give them an edge over retail traders because they can see orders coming into the market that are only partially executed. If you only have a thousand shares for sale on Nasdaq but you press the buy order for 5,000, you fill the thousand with Nasdaq, then it reroutes to the others. So they now see an order for one out of 5,000 is filled, it's coming into the next exchange, and they can act and, before it gets there, pull their offer. So instead of you getting that price, they fill you higher."
Algos and HFTs can operate in real-time micro fractions of a second and jump in front of you on a trade.
"I find that the type of stocks that are going to be more popular among algos and HFTs are going to be stocks that are extremely liquid, with low volatility, because [the algo operators] carry risk by holding shares in their inventory. So, if they're holding shares of something like a Silicon Valley Bank [around the time of the recent bank collapse crisis], the second that SVB breaks outside standard deviation and is down more than 10%, it would make sense that the algo operators would say, 'Let's stop participating and making the market for the stock because there's way too much risk.'"
In real time, Warrior's Cameron can often see the slippage when he presses the buy or sell button. Slippage is when your order fills higher or lower than current market prices, and it's usually because a HFT algo jumped in front of your order.
"And I might seem to fill 5 cents higher than the quote I was looking at before I pressed the buy button." In other words, algos and HFTs are responding in real time, and the sudden price bump can often be attributed to them. Cameron refers to them as "Algo Spikes" and "Algo Flushes."
But Ross Cameron says none of this is something of which to be fearful. Instead, it's something to understand and take into consideration when a day trader is formulating their strategy.
Factoring Algos Into Trading Strategy
As part of his own day-trading strategy, Warrior's Cameron tends to avoid the very liquid and low-volatility stocks because he believes that they're dominated by high-frequency trading algorithms and market makers that feel comfortable holding such stocks for longer periods of time.
"These market participants aren't concerned about the risk of the stock going up or down 100% in one day," he says, holding up Tesla as an example. "Tesla is somewhat volatile, but it's also very liquid. Those are the types of stocks where retail traders aren't going to find much of an edge. One of the edges that I find that I have is a combination of technical analysis and tape reading, so the ability to read the Level 2, to read the tape, that's a lot easier to read when you're trading with and among actual traders versus trading against algorithms."
Often, other traders will ask if he's worried that day-trading is going to be taken over by algos and that day-trading won't exist anymore because algos are becoming so advanced and pervasive.
"One of the things I've said for a long time is that I don't think the market makers, with their supersophisticated algorithms, are going to try to optimize those algos for trading penny stocks and small-cap stocks under $20 or $15," Cameron says, explaining that he believes there simply isn't enough money to be made for big fish in those particular markets.
"You might think, 'Well, geez, they're money hungry, they're going to try to make money everywhere.' But anyone, someone who owns a restaurant, is not also going to open a hot dog stand on the corner.
"Maybe there's money to be made there, but you focus on what you're good at. Everyone has to prioritize their energy on what gives them the most bang for their buck. "That creates, in a lot of ways, an incredibly efficient market because there are people at every level, they're trying to capture opportunity."
Warrior's Cameron Advises: Go Where the Algos Don't Go
Ross Cameron explains that algo traders, market makers, and HFTs are all trying to capture opportunity. And that opportunity inevitably lies in stocks with high volume.
"With a small account [operating where the algos don't go], I can do well. But for these market makers with very, very large accounts, it's almost like that part of the market wouldn't even be worth it, the potential for gain, the consistency versus the risk," he says
Warrior's Cameron says there are pockets of the market that you will see dominated by institutional traders - large caps, mid-caps, commodities, certain currency pairs. But then there are markets that for institutional players, the economies of scale they need simply aren't there.
"It may make sense for someone that is willing to work for a little bit less, just like the person who might be very content to run a hot dog stand on the corner," he says.
One of the keys to day-trading, concludes Ross Cameron, is identifying the different layers of the market based on the trader's own risk tolerances, account sizes, and individual trading strategy.
