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Do Day Traders Compete Against High-Frequency Traders (HFT)?

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Written By
Dan Buckley
Contributor Image
Written By
Dan Buckley
Dan Buckley is an US-based trader, consultant, and part-time writer with a background in macroeconomics and mathematical finance. He trades and writes about a variety of asset classes, including equities, fixed income, commodities, currencies, and interest rates. As a writer, his goal is to explain trading and finance concepts in levels of detail that could appeal to a range of audiences, from novice traders to those with more experienced backgrounds.
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Updated
Sep 10, 2024

Various types of traders use different strategies to profit from markets. 

Day traders and high-frequency traders (HFTs) are two kinds of traders, each with their own pool of capital, strategies, and buying/selling motivations. 

Both focus on short-term price fluctuations, but their methods, analysis and frameworks, and impact on the market differ a lot. 

In this article, we’ll look at the question: Do day traders compete against high-frequency traders?

To answer it, we’ll look into the characteristics of both day traders and HFTs, their strategies and analysis methods, and analyze how their activities intersect in the markets. 

We’ll also consider the challenges and opportunities that come from their coexistence and the broader implications for market structure and efficiency.

 

Key Takeaways – Day Traders vs. High-Frequency Traders

  • Different niches
    • Day traders and HFTs have distinct roles in the market ecosystem.
    • Day traders focus on manual analysis and longer intraday timeframes.
    • HFTs use automation for trades that often last microseconds.
  • Speed disadvantage
    • Day traders can’t compete directly with HFTs on speed and execution.
    • As such, they should focus on strategies that leverage human insight and longer-term pattern recognition.
  • Adapted strategies
    • Successful day traders use longer timeframes, might specialize in certain markets, and develop an edge in some way.
  • Market impact
    • HFTs have increased liquidity and tightened spreads, benefiting day traders but also can alter market dynamics (e.g., delta and gamma hedging leading to changes in the underlying securities).
  • Regulation
    • Ongoing debates about market fairness and new regulations to better level the playing field continue to shape the environment for both groups.

 

Defining Day Traders and High-Frequency Traders

It’s important understand what distinguishes these two groups.

Day Traders

Day traders are individual or institutional traders who buy and sell financial instruments within the same trading day. 

Their goal is to profit from short-term price movements, often closing all positions before the market closes. 

Key characteristics of day traders include:

  1. Manual decision-making – Day traders typically analyze charts, news, and other market data to make trading decisions. Orders are typically done by hand rather than through algorithms (though some day traders do algorithmic trading).
  2. Longer holding periods – Compared to HFTs, day traders may hold positions for minutes or hours.
  3. Lower trading frequency – Day traders execute fewer trades per day than HFTs, often ranging from a handful to several dozen.
  4. Use of technical analysis – Many day traders rely heavily on technical indicators and chart patterns to inform their trades. Fundamental analysis is less common due to the longer-term nature of securities reflecting fundamental value.
  5. Diverse strategies – Day traders may employ various strategies, such as momentum trading, scalping, or news-based trading.

High-Frequency Traders

High-frequency trading is a subset of algorithmic trading that uses high-powered computers to transact a large number of orders at extremely high speeds. 

HFTs are characterized by:

  1. Automated decision-making – HFTs use algorithms to analyze market data and execute trades without human intervention.
  2. Extremely short holding periods – Positions may be held for fractions of a second to minutes.
  3. Very high trading volume – HFTs can execute thousands or even millions of trades per day.
  4. Low latency – HFTs invest heavily in technology and infrastructure to reduce the time between receiving market data and executing trades.
  5. Proprietary strategies – HFTs often use sophisticated statistical and mathematical models to identify trading opportunities.
  6. More regulatory scrutiny – High-frequency trading has faced criticism for contributing to market volatility at times and giving an unfair advantage to certain segments of the market. As a result, HFT is often subject to strict regulatory oversight to maintain market fairness and stability.

 

Strategies and Tools

The strategies, analysis, and frameworks used by day traders and HFTs highlight the fundamental differences in their approaches to the market.

Day Trader Strategies

  1. Trend following – Identifying and trading in the direction of short-term market trends.
  2. Contrarian trading – Taking positions opposite to the prevailing market sentiment.
  3. News-based trading – Capitalizing on price movements following significant news events.
  4. Breakout trading – Entering positions when price breaks above or below key levels.
  5. Scalping – Making numerous small profits on minor price changes throughout the day. Higher trade frequencies than traditional day trading.
  6. Price action/support and resistance trading – Monitoring chart patterns for potential signals to trade on.

High-Frequency Trading Strategies

  1. Market making – Providing liquidity by continuously quoting buy and sell prices.
  2. Statistical arbitrage – Exploiting pricing inefficiencies between related securities.
  3. Latency arbitrage – Profiting from speed advantages in accessing and acting on market information.
  4. Order anticipation – Detecting large incoming orders or repeated orders (e.g., an institution trading recurringly at a certain time using certain criteria that can be reverse-engineered) and trading ahead of them.
  5. Momentum ignition – Initiating a series of trades to trigger other market participants to trade; can be controversial.
  6. Mean reversion – Expecting things that get out of whack to get back in line.
  7. And many more covered in more detail here.

Software, Data, Platforms, Tools, and Technology

The tools used by day traders and HFTs reflect their different scales of operation:

Day traders typically use:

HFTs use:

  • Custom-built, high-speed computer systems and ultra-low latency networks
  • Colocation services to place servers near exchange matching engines
  • Advanced/unique data feeds and market connectivity
  • Unique algorithms and AI/ML/deep learning techniques to analyze in unique ways that give them an edge

 

Direct Competition: Myth or Reality?

Given the stark differences in their approaches, do day traders and HFTs compete against each other? 

The answer is nuanced and depends on several factors.

Areas of Potential Competition

  1. Liquidity provision – Both day traders and HFTs can provide liquidity to the market, potentially competing for the same opportunities.
  2. Short-term price movements – Both groups try to profit from intraday price fluctuations, which could lead to competition in identifying and acting on these movements.
  3. Order flow – In some cases, day traders and HFTs might be on opposite sides of the same trades, directly competing for favorable execution prices.

Asymmetries in Competition

Despite these areas of overlap, several factors create significant asymmetries in the competition between day traders and HFTs:

  1. Speed advantage – HFTs operate at speeds that are simply unattainable for human day traders. This gives HFTs a significant edge in reacting to market events.
  2. Information processing – HFTs can analyze vast amounts of data and execute trades based on this analysis faster than any human or discretionary trader could.
  3. Capital and technology – HFTs typically have access to far greater capital and more advanced technology and infrastructure than individual day traders.
  4. Market impact – The volume of HFT activity can influence market dynamics in ways that day traders must react to rather than compete with directly.*

*For example, take HFTs hedging operations.

Delta hedging involves adjusting the position of an options portfolio to become neutral to small changes in the underlying asset’s price, while gamma hedging tries to minimize the risk from large price movements by managing the portfolio’s sensitivity to changes in delta.

Together, they help traders manage risk by stabilizing the portfolio against various changes in their positioning.

Nonetheless, if hedging operations are highly skewed in a certain direction, this can create certain dynamics in the underlying securities.

An example would be “gamma squeezes” where HFTs and market-making algorithms are driving the underlying strongly due to their hedging activities.

Indirect Effects and Adaptations

While direct competition between day traders and HFTs may be limited, the presence of HFTs in the market has important indirect effects on day traders.

Market Structure Changes

  1. Increased liquidity – HFT activity has generally led to tighter bid-ask spreads and increased liquidity. This can benefit day traders where low spreads and transaction costs are very important because of the higher trade volume and smaller price movements per trade.
  2. Faster price discovery – HFTs contribute to more efficient price discovery, potentially reducing some opportunities for day traders but also creating more efficient, liquid markets.
  3. Altered volatility patterns – The presence of HFTs has changed intraday volatility patterns, requiring day traders to adapt their strategies.

Adaptations by Day Traders

In response to the changing market landscape, day traders have adapted in several ways:

  1. Focusing on different timeframes – Some day traders have shifted to slightly longer timeframes if they feel the competition is less pronounced – not just HFTs but the difficulty of small time scales, in general.
  2. Specializing in specific market conditions – Day traders may focus on particular market scenarios or anomalies that are less attractive to HFTs.
  3. Leveraging technology – Many day traders have invested in better technology and data feeds to narrow the gap with HFTs and other institutional traders.
  4. Developing new strategies – Day traders can’t compete on speed of execution, but can turn toward other analysis techniques.

 

Regulatory Considerations

The coexistence of day traders and HFTs has prompted regulatory scrutiny and action, which affects both groups:

  1. Order types and market structure – Regulators have introduced new order types and market structure changes to help level the playing field.*
  2. Circuit breakers and volatility controls – These mechanisms, designed to prevent extreme market movements, affect both day traders and HFTs.
  3. Transparency requirements – Increased reporting and transparency rules have been implemented, potentially benefiting day traders by providing more market information.
  4. Debate over market fairness – Ongoing discussions about the fairness of HFT practices could lead to further regulatory changes that impact the competitive landscape.

*For example, regulators have implemented rules like the “trade-at” provision, which prioritizes displayed orders over hidden liquidity, and introduced circuit breakers to prevent market crashes like the 2010 Flash Crash.

These measures try to reduce the advantage HFTs have over day traders and institute fairer trading conditions for all participants.

Conclusion: Coexistence Rather Than Direct Competition

Day traders and high-frequency traders operate in the same markets and may occasionally find themselves on opposite sides of trades, but they’re not necessarily direct competitors. 

The vast differences in their operational methods, technological capabilities, and scale of activity mean that they often occupy different niches within the markets.

Day traders, with their human decision-making processes and longer time horizons (relatively speaking), identify and capitalize on opportunities that require contextual understanding, pattern recognition over longer timeframes, and adaptation to changing market narratives. 

HFTs, on the other hand, excel at exploiting micro-inefficiencies and providing liquidity at a scale and speed that day traders – and humans, in general – can’t match.

Rather than direct competitors, day traders and HFTs are more akin to different species in the same ecosystem, with each adapted to their own particular niche. 

The presence of HFTs has changed the environment in which day traders operate, so this can require adaptation and may have eliminated some traditional day trading strategies. 

For instance, scalping strategies that rely on small price fluctuations may become less effective due to HFTs executing trades faster than day traders can react.

But HFT (especially market making) has nonetheless also created new opportunities due to tighter spreads and, in many ways, a more efficient and liquid market.