Systematic Trading for All?
Part 1
This is the first article in a series on consumer systematic trading of currencies, crypto and stocks. Here, “systematic” means automated, relatively frequent, and controlled by a trading strategy expressed in code. If you enjoy it, please share it with others who might also find it interesting or informative.
I’ve spent most of my career working with an unlikely cast of characters to give a trading edge to some of the wealthiest organizations on the planet. Why unlikely? Because they had to combine a tolerance for working in high-stakes environments with a talent for engineering at the limits of software and hardware performance.
At the beginning, one thing impressed itself upon me immediately. Even in highly driven and resourced organizations, the vast majority of projects fail. The few people that actually delivered were identified and indulged. And while I always enjoyed this line of work and the unique engineering challenges involved, I was persistently concerned by the secrecy and inequality. Of course nothing stays secret forever. Books like Dark Pools lifted the lid, and these days it’s relatively easy to subscribe to STAC and find out what people are using. So anyone should be able to run a high-frequency trading strategy, right? Sadly, no. Those at the top of the HFT game continue to spend millions of dollars on accelerating their trading, and they hoard their technology.
The Other End of The Spectrum
Meanwhile, on the flip side there are about 100 million individuals worldwide actively trading currencies (FX), stocks, crypto, futures and options. These people range from Japanese housewives trading FX, to professional gamblers in the US who like to trade high-leverage options, to crypto “degens” and many others from all walks of life. All aspire to be effective investors by actively trading and speculating using the tools available to them. Unfortunately, even in DeFi crypto, these tools aren’t on a par with those used by the organizations they trade against. With the move to 24x7 markets, many have trouble sleeping - they don’t trust their tools to keep them safe overnight - requiring them to close positions before they turn in. If they use automated trading, it tends to run on a desktop computer in their home office that’s prone to the occasional crash or loss of power, or on a mobile phone that might suddenly decide to install a software update or lose signal.
Tellingly, this entire class of investor is derided by top-tier institutions as “uninformed flow”. There are countless articles dissuading individuals from attempting to “time the market”. This is all in marked contrast to order flow from hedge funds and market-makers, which is termed “informed flow”. Consumer trading strategies are so ineffective, in all markets, that systematically trading against them is profitable! The phenomenon of “payment for order flow” relies on this.
However, despite their disadvantages, quite a few individual active traders do win outsized profits, particularly in bull markets. Of course, a rising tide lifts all boats. When it comes to trading, a bull market can catapult some fortunate traders to the moon. Everyone involved attributes such success to their incredibly effective strategies rather than their outsized risk appetite, and in a few cases there’s some truth to it. Scrutiny of such cases reveals some interesting observations.
High Speed vs Low Speed
It’s well known that frequent systematic trading by individuals with small amounts of deployed capital is prone to slow processing, high trading costs and “slippage”. This is known as “over trading”, and it often negates theoretical gains. Unethical brokers encourage it. But if you scrutinize the trading records of highly successful individual traders, you often observe relatively infrequent trading. Orders are placed due to diligently gleaned insights, with careful use of leverage to amplify returns. Holding periods (the period between buying and selling) tend to be at least a few days if not months. Large model AI assists in the development of signals that drive this style of low-frequency investing. (All successful traders also tend to have strong risk management, discipline and intellectual rigor). This type of strategy is latency-insensitive - the fact that orders take a long time to get to the market, transiting many systems and networks, doesn’t invalidate investment decisions. (In this context “a long time” means several tenths of a second).
In contrast, a high-frequency trader uses latency-sensitive strategies. In the fastest global markets, they will expect a delay of no more than 1 or 2 microseconds (millionths of a second) from a new order departing their systems and arriving at the market. The fastest market gateways are built with custom hardware and process orders sub-microsecond (until fairly recently I used to build such things). Institutions pay millions to place their top-of-the line hardware servers in data center racks that are adjacent to the market, connecting to it with special network cabling that is optimized for short distances. Systematic hedge funds will access markets via their prime brokers, who operate and share such infrastructure.
The Data Gap
But low speed is not the only obstacle confronting consumers - there are serious deficiencies in the information available to them. Many consumer trading bots are entirely driven by price charts in the form of “bars”, neglecting a whole range of other important inputs. Institutional-grade strategies are constructed very differently. Level 2 tick-by-tick market data is a much richer feed of information than a price bar chart. Additional key inputs are trading costs, depth of market, market data from other venues and linked assets such as derivatives, volume analysis, real-time realized and unrealized P&L, volatility and market risk, concentration risk and liquidity risk.
Better Tools
So are individual consumers who want to time the market doomed? Relying on ineffective strategies, voodoo chart indicators, bull markets and luck? I hope not. Our company Psi Labs was founded to democratize systematic trading. I’d like to help consumers develop and run strategies that can trade at high speed with confidence. Although single-digit microsecond latency will remain out of reach to individuals for now, a properly designed and implemented cloud platform should be able to reliably deliver sub-millisecond latency along with the information needed to be effective. Such a platform would be fast enough to host strategies to competently trade FX, crypto, stocks and other assets.
Institutions will also continually re-balance their portfolio allocations to various strategies, and manage their trading power at the brokers and venues they use. They will also be actively managing custody and settlement risks. Consumers should have equivalent command and control of their automated trading.
That’s why for the past few weeks, I’ve been diving into the world of consumer automated trading to figure out what’s already out there, how effective it is, how it is used, and how it can be improved. What I found surprised me in a lot of ways. But one of my initial instincts was validated - millions of individual investors use automated trading, want to engage in frequent trading at speed, and strongly desire to do it more effectively with better tools.
Are you one of these investors? In the second article in this series I’ll share what I discovered, including a roundup of every consumer automated trading platform I could find in FX, crypto and stocks.