What Is High-Frequency Trading? (2024)

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

These high-frequency trading platforms allow traders to execute millions of orders and scan multiple markets and exchanges in a matter of seconds, thus giving institutions that use the platforms an advantage in the open market.

The systems use complex algorithms to analyze the markets and are able to spot emerging trends in a fraction of a second. By being able to recognize shifts in the marketplace, thetrading systems send hundreds of baskets of stocks out into the marketplace at bid-ask spreads advantageous to the traders.

Key Takeaways

  • High-frequency trading is an automated trading platform that large institutions use to transact many orders at high speeds.
  • HFT systems use algorithms to analyze markets and spot emerging trends in a fraction of a second.
  • Critics see high-frequency trading as an unfair advantage for large firms against smaller investors.

By essentially anticipating and beating the trends to the marketplace, institutions that implement high-frequency trading can gain favorable returns on trades they make by virtue of their bid-ask spread, resulting in significant profits.

Understanding High-Frequency Trading

The Securities and ExchangeCommission (SEC)has no formal definition of HFT but attributes certain features to it:

  1. Use of extraordinarily high speed and sophisticated programs for generating, routing, and executing orders
  2. Use of co-location services and individual data feeds offered by exchanges and others to minimize network and other latencies
  3. Very short time-frames for establishing and liquidating positions
  4. Submission of numerous orders that are canceled shortly after submission
  5. Ending the trading day in as close to a flat position as possible (that is, not carrying significant, unhedged positions overnight)

High-frequency trading became commonplace in the markets following the introduction of incentives offered by exchanges for institutions to add liquidity to the markets.

By offering small incentives to these market makers, exchanges gain added liquidity, and institutions that provide the liquidity also see increased profits on every trade they make, on top of their favorable spreads.

Although the spreads and incentives amount to a fraction ofacent per transaction, multiplying that by a large number of trades per day amounts to sizable profits for high-frequency traders.

Critics see high-frequency trading as unethical and as giving an unfair advantage for large firms against smaller institutions and investors.Stock markets are supposed to offer a fair and level playing field, which HFT arguably disrupts since the technology can be used for ultra-short-term strategies.

High-frequency traders earn their money on any imbalance between supply and demand, using arbitrage and speed to their advantage. Theirtrades are not based on fundamental research about the company or its growth prospects, but on opportunitiesto strike.

Though HFT doesn’t target anyone in particular, it can cause collateral damage to retail investors,as well as institutional investors like mutual funds that buy and sell in bulk.

What Is High-Frequency Trading? (2024)


What Is High-Frequency Trading? ›

Broadly defined, high-frequency trading (a.k.a "black box" trading) refers to automated, electronic systems that often use complex algorithms (strings of coded instructions for computers) to buy and sell much faster and at much greater scale than any human could do (though, ultimately, people oversee these systems).

What is high-frequency trading explained simply? ›

High-frequency trading (HFT) is an automated form of trading. It involves the use of algorithms to identify trading opportunities. HFT is commonly used by banks, financial institutions, and institutional investors. It allows these entities to execute large batches of trades within a short period of time.

What is HTF trading? ›

What is HTF? ● 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? ›

Finally, HFT has been linked to increased market volatility and even market crashes. Regulators have caught some high-frequency traders engaging in illegal market manipulations such as spoofing and layering.

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.

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.

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.

Is high-frequency trading evil? ›

No. High frequency trading provides two important services to the market: adding liquidity and very efficient price discovery. These services used to be provided mostly by specialists at large banks with far less efficiency and much greater end user cost.

Is HFT legal in the US? ›

Yes, high-frequency trading is legal.

How hard is it to get into high-frequency trading? ›

You will likely have to work hard to find a role and it could take some time. While direct application to such firms is possible, the tricky part is figuring out which firms actually take part in HFT! Often, if you are well-known in your particular technical niche, the firms will try and recruit you directly.

What is the average return on HFT? ›

substantially higher returns than Passive HFTs -- the average Aggressive HFTs earns an annualized alpha of 90.67%, while the average Passive firm earns 23.22% -- suggesting that there is a strong profit motive for liquidity taking rather than liquidity providing.

What is the best indicator for high-frequency trading? ›

What is the best indicator for high-frequency trading? Moving average (MA), Exponential moving average (EMA), Stochastic oscillator, and Moving average convergence divergence (MACD) are the best indicators for high-frequency trading.

How do you detect high-frequency trading? ›

Order-to-trade ratio (OTR)

It identifies traders who are amending or cancelling orders at a far higher rate than they are trading. High-frequency traders are usually identified to have a ratio greater than 15.

What is an example of HFT strategy? ›

One of the first examples of HFT was the SOES Bandits trading strategy, which used the Small Order Execution System for NASDAQ stocks. SOES Bandits exploited the price differences between market makers and retail investors, profiting from short-term price fluctuations.

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.

What is the high-frequency trading mechanism? ›

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!

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