What is high-frequency trading (HFT)?
High-frequency trading (HFT) is a kind of trading in which several orders are transacted in milliseconds, thanks to the employment of robust computer systems. HFT analyzes several markets using sophisticated algorithms and then executes orders in response to changes in the market. Generally, traders who execute their trades more quickly than others are more lucrative. High order-to-trade ratios and turnover rates are further characteristics of HFT.
Gaining Knowledge About High-Frequency Trading (HFT)
Algorithmic trading includes high-frequency trading. HFT allows traders to make judgments and execute deals in seconds by analyzing crucial data. HFT tracks market movements and spots arbitrage possibilities while enabling massive quantities of transactions in a short period of time.
Among the essential characteristics of high-frequency trading are the following:
- transacting quickly
- Many trades were completed.
- Brief investment time frames
Given its complexity and subtleties, it is hardly unexpected that banks, other financial institutions, and institutional investors often employ HFT.
It gained popularity when exchanges began to provide incentives for businesses to increase market liquidity. For example, the supplementary liquidity providers (SLPs) group on the New York Stock Exchange (NYSE) aims to increase competition and liquidity for current quotations on the market.
After Lehman Brothers collapsed in 2008, investors were deeply concerned about liquidity, which led to the introduction of the SLP. The NYSE pays a charge or rebate to corporations in exchange for providing such liquidity. Millions of transactions occur daily as a consequence, yielding substantial revenues.
Citadel LLC, Virtu Financial, and Tower Research are a few of the most well-known HFT companies.
Benefits and Drawbacks of HFT
Positives
The primary advantages of high-frequency trading are its simplicity and quick transaction execution. Banks and other dealers can complete many deals quickly—typically in seconds.
Increased market liquidity and the elimination of bid-ask spreads that would have been too tiny were two benefits of HFT. Fees were added to HFT to test this, which caused bid-ask spreads to rise. One study evaluated the impact of government-imposed HFT fees on Canadian bid-ask spreads. It was discovered that there was a 13% rise in market-wide bid-ask spreads and a 9% increase in retail spreads.
Ryan Riordan, Andreas Park, and Katya Malinova. “Do high-frequency traders hurt retail investors?” SSRN, January 11, 2018.
The drawbacks
HFT is divisive and has drawn some negative feedback. It has taken on the role of many broker-dealers and makes choices using mathematical models and algorithms, eliminating the need for human judgment and contact.
Millisecond decisions might lead to sudden and significant changes in the market. For instance, the Dow Jones Industrial Average (DJIA) saw its worst intraday point decline to that date on May 6, 2010, plunging 1,000 points and 10% in only 20 minutes before rebounding once again. A government investigation found that a sizable order resulting in a sell-off caused the collapse.
HFT is criticized for enabling big businesses to make money from small people. Another point of criticism is its ‘ghost liquidity’: HFT provides liquidity to the market, but it disappears from the market the next second, making it impossible for traders to trade this liquidity.
Pros:
- A lot of transactions happening at once
- Simple and quick procedure
- Boosts the liquidity of markets
- Eliminates little bid-ask spreads
Cons:
- Eliminates human contact and decision-making
- Quick transactions might lead to significant changes in the market.
- Traders do not trade liquidity.
How Does Trading at High Frequency Operate?
An automated trading method is known as high-frequency trading. Algorithms are used to find trading opportunities. Banks, financial institutions, and institutional investors employ HFT often. These entities can quickly execute enormous quantities of deals because of it. Everything is computerized, which makes trading simple. Liquidity is supplied to the market via HFT. However, it eliminates the human element and may lead to significant market fluctuations.
Does high-frequency trading take place in the cryptocurrency market?
In the bitcoin market, high-frequency trading does happen. It functions in other markets in the same manner as HFT. It analyzes cryptocurrency data using algorithms and quickly completes many deals all at once—typically in a matter of seconds.
What Is the Speed of a High-Frequency Trade?
Trading at high frequency is quick. It has a maximum speed of ten milliseconds. It may even be less in some circumstances when executing many deals.
The Final Word
The trading world is one of the many areas of financial business that have evolved thanks to technological advancements. Computers and algorithms have made finding possibilities simpler and quickly completing trades easier. Major trading organizations can swiftly execute large orders thanks to high-frequency trading. HFT (and other algorithmic trading forms) simplify things, but they also have disadvantages. Most importantly, they risk triggering significant market movements, as they did during the Dow’s significant intraday decline in 2010.
Conclusion
- HFT is sophisticated algorithmic trading where a lot of orders are filled quickly.
- It reduces tiny bid-ask spreads and increases market liquidity.
- HFT is chastised for giving big businesses an advantage in trading.
- Another complaint is that because this kind of trading generates temporary liquidity, traders can’t profit from it.
