What Is High-Frequency Trading (HFT)? | The Motley Fool (2024)

High-frequency trading (HFT) uses algorithms and extremely fast connections to make rapid trades, often in fractions of a second. It frequently involves the use of proprietary tools and computer programs that analyze markets, identify trends, and execute trades for very short-term gains. We’ll discuss the characteristics of high-frequency trading, strategies, pros and cons, and examples of how high-frequency trading has affected markets.

What Is High-Frequency Trading (HFT)? | The Motley Fool (1)

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What is it?

What is high-frequency trading?

High-frequency trading (HFT) takes advantage of proprietary computer algorithms and super-fast (and often proprietary) connections to analyze securities, identify opportunities, and execute trades for extremely short-term gains.

HFT has become more common as computers have become more sophisticated, and innovations such as fiber-optic cables have helped give some traders an edge when it comes to exploiting market trends that appear and disappear within fractions of a second.

The Securities and Exchange Commission (SEC) lists five criteria to describe HFT:

  • Use of high-speed, sophisticated programs to generate and execute trades.
  • Use of individual data feeds and co-location services to ensure maximum speed.
  • Short time frames for buying and selling.
  • Submission of multiple canceled orders.
  • Ending the trading day with little (if any) significant, unhedged positions.


High-frequency trading strategies

HFT makes extensive use of arbitrage, or the buying and selling of a security at two different prices at two different exchanges. Although the strategy can be extremely risky, even a small difference in price can yield big profits. HFT algorithms can detect very small differences in prices faster than human observers and can ensure that their investors profit from the spread.

In his classic 2014 book, Flash Boys, author Michael Lewis describes three main types of arbitrage used by high-frequency traders:

Slow-market arbitrage: Traders can use fast connections to take advantage of different data speeds at different exchanges. Since not all exchanges operate at the same speed, there are often price differences among them, especially in foreign markets. Slow market arbitrage, however, has turned into a bit of an arms race, with hedge funds spending millions for high-speed connections that will provide an edge measured in milliseconds.

Dark-pool arbitrage: HFT firms can use this type of arbitrage to take advantage of the differences in price between exchanges and dark pools, or private exchanges that aren’t available to public investors. Because dark pools don’t immediately publish prices in their dark pool, there’s often a difference in price that can be exploited by high-frequency traders.

Rebate arbitrage: High-frequency traders take advantage of different exchange rules involving rebates. Some exchanges provide buyers with a rebate while charging sellers a fee; some give the rebate to sellers and charge a fee to buyers. HFT firms exploit the system by purchasing one stock from a stock exchange that offers a rebate to buyers and then quickly selling it -- at the same price -- to another exchange that offers a rebate to sellers. Although the rebate amounts are typically quite small, tiny profits can turn into much larger ones when very large blocks of stocks are involved.

Pros and Cons

High-frequency trading pros and cons

Advocates of high-frequency trading contend that the technique ensures liquidity and stability in the markets because of its ability to very rapidly connect buyers and sellers with the best bid-ask spread.

The use of algorithms also ensures maximum efficiency since high-frequency traders design programs around preferred trading positions. As soon as an asset meets a pre-determined price set by the algorithm, the trade occurs, satisfying both buyer and seller.

But critics argue that high-frequency trading serves no valuable economic purpose. Instead of making trades based on the actual value of a security, high-frequency traders are simply taking advantage of extremely short-term changes.

High-frequency trading also has been linked to increased market volatility, and critics also argue that HFT firms benefit at the expense of individual investors who don’t have access to sophisticated algorithms and extremely high-speed connections.

Related investing topics

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Day Trading Definition: Why It Differs From InvestingSimilar to gambling, investors try to profit on market ups and downs. Is it worth it?
Can You Buy a Stock and Sell It in the Same Day?Same-day stock trading can subject you to a higher level of regulatory scrutiny -- and financial risk.
What Is a Hedge Fund?When wealthy investors put their money together to beat the market.

High-frequency trading and markets

High-frequency trading and markets

Although most HFT firms are essentially competing against other HFT firms rather than buy-and-hold investors, high-frequency trading has played a major role in some of the biggest market shakeups over the last 40 years.

In 1987, high-frequency trading was linked to the “Black Monday” stock market crash that erased 22.6% from the Dow Jones Industrial Average, the biggest one-day percentage loss in history. As is often the case with market crashes, no single factor was responsible for the downturn. But almost all researchers acknowledge that algorithmic trading played a key role in the epic sell-off.

Another crash tied to high-frequency trading occurred in 2010, with a “flash crash” that wiped almost $1 trillion in market value off investor books in only a few minutes. The Dow lost almost 1,000 points in 10 minutes but recovered about 600 points over the next 30 minutes. An SEC investigation found that negative market trends were exacerbated by aggressive high-frequency algorithms, triggering a massive sell-off.

Opinions vary about whether high-frequency trading benefits or harms market performance. Either way, wise traders don’t try to time market trends; for the typical investor, a long-term buy-and-hold strategy will invariably outperform technology built for the short term.

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What Is High-Frequency Trading (HFT)? | The Motley Fool (2024)


What is high-frequency trading explained simply? ›

What is high-frequency trading? High-frequency trading is a type of automated trading that uses powerful computers to buy and sell financial assets incredibly quickly. The term “high frequency” refers to how quickly these trades are completed. They may take place in minutes, seconds or even milliseconds!

What is the high-frequency trading? ›

High-frequency trading (HFT) is an automated trading platform that large investment banks, hedge funds, and institutional investors employ. It uses powerful computers to transact a large number of orders at extremely high speeds.

What is HTF trading? ›

High Frequency Trading : Most commonly known as trades taking place in time intervals ranging from hours to microseconds and the volumes of the stocks traded tend to be quite large ~ around 50,000 shares at a time.

Why is high-frequency trading illegal? ›

Ethics and Market Impact

Some professionals criticize high-frequency trading since they believe that it gives an unfair advantage to large firms and unbalances the playing field. It can also harm other investors that hold a long-term strategy and buy or sell in bulk.

What is an example of HFT? ›

High-frequency trading can allow investors to take advantage of arbitrage opportunities that last for fractions of a second. For example, say it takes 0.5 seconds for the New York market to update its prices to match those in London. For half of a second, euros will sell for more in New York than they do in London.

Is high-frequency trading still profitable? ›

This type of trading can be very profitable but also carries significant risks. In simple terms, HFT is a method that employs powerful computers to execute a vast number of orders in fractions of a second. It employs advanced algorithms to analyze various markets and execute trades based on current market conditions.

Can you make money with high-frequency trading? ›

High-frequency trading strategies

Although the strategy can be extremely risky, even a small difference in price can yield big profits. HFT algorithms can detect very small differences in prices faster than human observers and can ensure that their investors profit from the spread.

Do brokers allow HFT trading? ›

Yes, high-frequency trading is legal. That being said, it's possible that high-frequency trading strategies will not be permitted by your broker. Price-driven strategies (such as scalping) or latency-driven arbitrage strategies are prohibited altogether by some brokers.

What are the risks of high-frequency trading? ›

High-frequency trading offers significant benefits to online Forex brokers, including speed, liquidity provision, risk management, and data analysis. However, it also comes with disadvantages such as increased market volatility, concerns about market manipulation, high infrastructure costs, and regulatory scrutiny.

What is BTD trading? ›

BTST stands for "Buy Today, Sell Tomorrow." It is a trading strategy used in the stock market. BTST trading is based on a simple premise: purchase shares on one day and sell them on the following day, ideally for a profit. This strategy essentially leverages the concept of overnight price movements in the stock market.

Can you do high-frequency trading from home? ›

High frequency trading can be done from home if you have enough money to trade and have top-of-the-line technology for order execution and speed.

What is HTF structure in trading? ›

The HTF Candle Projections indicator shows a number of candles from a higher time frame (HTF) projected to the right of the candles in the current timeframe. This can be very useful if you want to analyze two different timeframes without the need to switching between the different timeframes.

Can normal people do high-frequency trading? ›

All of the HFTs are computer generated algo orders. There are no human traders as the speed of execution of orders can only be done by a super fast expensive computer system.

What is the point of high-frequency trading? ›

Traders are able to use HFT when they analyze important data to make decisions and complete trades in a matter of a few seconds. HFT facilitates large volumes of trades in a short amount of time while keeping track of market movements and identifying arbitrage opportunities.

Why is HFT unfair? ›

HFT can give traders an unfair advantage if they engage in market manipulation. HFT computers can influence the market for the trader's own advantage. Take the case of Trillium Capital.

What is high-frequency trading also known as? ›

It is estimated that 50 percent of stock trading volume in the U.S. is currently being driven by computer-backed high frequency trading. Also known as algo or algortihmic trading.

What is the disadvantage of high-frequency trading? ›

High-frequency trading offers significant benefits to online Forex brokers, including speed, liquidity provision, risk management, and data analysis. However, it also comes with disadvantages such as increased market volatility, concerns about market manipulation, high infrastructure costs, and regulatory scrutiny.

How do you detect high-frequency trading? ›

Detecting high-frequency traders
  1. Order-to-trade ratio (OTR) The order-to-trade ratio metric calculates the total number of order messages divided by the number of trades at a broker, client or account level. ...
  2. Cancellation rates. ...
  3. Daily turnover. ...
  4. Message profiling. ...
  5. Quote stuffing. ...
  6. Sample 1. ...
  7. Sample 2. ...
  8. Timing.

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