What Is High-Frequency Trading: Could It Work for You?

How Does High-Frequency Trading Work?

HFT is typically used by institutions, experienced traders and brokers who have advanced tools and computational programs to implement their strategies. It’s a type of algorithmic trading with the aim of maximizing returns through automation. 

For this purpose, HFT algorithms are designed to instantly respond to market changes and place a large number of orders. Profits depend on both the speed of program execution and the effectiveness of the underlying strategy.

High-frequency trading has been a huge change for the financial markets. 

It all started with the rise of electronic trading systems. 

Trader using multiple monitors to track the prices. Source: Gemini

In 1971, NASDAQ (National Association of Securities Dealers) started computer-assisted trading. This marked the beginning of the shift from face-to-face financial deals to digital processes.

The internet boom in the 1990s brought another change for traders, allowing them to access the markets from anywhere with an internet connection. This period is also considered the beginning of high-frequency trading, which developed hand in hand with improvements in network speed and data processing.

With time, computers and bots replaced crowded physical rooms where traders were intensely looking for profitable deals, placing their orders manually. 

HFT has had a large growth since the mid-2010s and now accounts for around 50% of total equity trading in the US and around 35% in Europe. 

Markets Where High-Frequency Trading Is Used 

First things first: a key factor for High-Frequency Trading is market volatility. HFT is primarily used as a short-term trading strategy, meaning the faster market prices change, the better the chances for algorithms to execute a higher number of trades and generate profit.

High-frequency trading has its distinguishing features for different markets:

• Stock market: This is where HFT started. Algorithms monitor stock exchanges and make thousands of buy and sell transactions per second. Price fluctuations are common in the stock market, which is greatly influenced by the world economy, company news, and buyers’ interests.

Want to see an example of HFT trading? Here’s an algorithm making 7,000 transactions in 7 seconds while trading S&P 500 futures contracts in 2008. This caused the price to drop, and trading was stopped for 10 seconds, after which the price started recovering. 

• Forex: Foreign Exchange, also called Forex or FX, is a global marketplace for buying and selling currencies. Traders buy one currency and sell another simultaneously, as currencies are listed in pairs, for example, EUR/USD or GBP/JPY. The fluctuations between currency rates make Forex an attractive place for HFT traders.

Unlike stock exchanges, which have opening and closing hours, Forex is open 24/7 on weekdays as it operates in multiple time zones.

• Crypto: Finally, crypto is the newest market of the three. Cryptocurrencies, except for stablecoins, are known for their volatile nature and non-stop operations. The characteristics of crypto make it a good option for HFT traders. First, market volatility enables traders to increase their profits, and the underlying blockchain infrastructure can provide high transaction speeds.

Crypto high-frequency trading can be conducted through centralized exchanges like Binance and Coinbase, as well as decentralized platforms like Uniswap or dYdX. Traders implement their strategies through bots, APIs, and other automation tools that scan different platforms and find the best prices to execute buy and sell orders.

Related: Crypto vs. Forex: What’s the Real Difference for Investors?

Common High-Frequency Trading Strategies 

Market participants use High-Frequency Trading technologies to execute different trading strategies quickly. This means that you can automate many traditional trading strategies with advanced tools. 

Common strategies for High-Frequency Trading. Source: Börse Group

Here are several strategies widely used in HFT trading in crypto, stocks, and Forex.  

Liquidity Provision 

This strategy is based on providing liquidity to the market and profit from the difference between buy and sell prices, known as the bid-ask spread. In this context, the crypto market offers more opportunities for individual investors. Stock and Forex are more established markets with higher liquidity that are primarily provided by large banks and institutions. 

In crypto, you can earn profits by providing liquidity to decentralized exchanges, and automated market makers (AMMs). For this purpose, you deposit cryptocurrencies into liquidity pools and earn a portion of the trading fees. Many platforms also offer rewards in their native tokens to encourage market participation. 

Arbitrage 

The same asset can be traded at slightly different prices across various platforms. A simple example of this is the foreign currency exchange rates offered by different banks. Seizing these opportunities, algorithms can buy an asset at a lower price on one platform and sell it higher on another. This arbitrage strategy allows traders to profit from price differences.

Algorithms identifying best prices to trade. Source: Gemini

Here, even small price differences can result in large gains given the high transaction volume typical of HFT. To implement crypto arbitrage, you mainly need to execute cross-exchange trades. Forex arbitrage is possible from discrepancies between different brokers or currency pairs. Meanwhile, there are fewer price differences for stocks. However, events like stock splits or major news releases can create temporary price changes.

Sniping 

Another popular strategy in high-frequency trading is sniping. Sniping is a tactical trading approach that involves making quick trades based on short-term price movements or news events. Sniping works great in crypto when the market gets really volatile, especially after big news drops. Traders keep a close eye on trends, updates, and social media, ready to jump on quick price changes.

Trader executing sniping strategy. Source: Gemini

In Forex, sniping usually happens around big economic announcements, like job reports or interest rate updates. Traders often set up their orders just before the news breaks to catch fast price moves. For stocks, it's related to earnings reports, mergers, or big market events.

Concerns Around High-Frequency Trading։ Does It Cause Volatility?

High-frequency trading is a controversial topic, with critics mentioning the risks of large trades on market prices. They argue that buying and selling large amounts of assets quickly can cause prices to fluctuate significantly and lead to a phenomenon known as a Flash Crash.

Different studies, including an analysis of Flash Crush by Andrei Kirilenko, point out that HFT and automated trading were the main reasons for the 2010 US stock market decline. On May 6, 2010, for instance, a trillion dollars were wiped out from the market before recovering. In a matter of minutes, the Dow Jones index, an indicator of value on the US stock market, lost over 1,000 points, which is almost 9% of its value.

In markets with lower liquidity, such as crypto, the impact of HFT can be more pronounced.

Another concern is that HFT gives large traders an unfair advantage over smaller investors who don’t have access to advanced trading tools and technology. These risks raise questions about the need for regulations.

In February 2024, China froze the accounts of a major quantitative trader for three days in a rare crackdown and announced stricter monitoring for “abnormal trading.”

The Other Side: Benefits of High-Frequency Trading

There are big disagreements around HFT. There’s a view that High-Frequency Trading is not to blame for market volatility and that HFT can actually benefit the market and traders.

Despite the use of technology playing a role in moving the market, as we mentioned above, HFT itself represents different strategies with various market participants placing both buying and selling orders.Because everyone engages in different types of trades, it’s unlikely that High-Frequency Trading can be a cause of a market crash, except in particular cases involving specially designed strategies.

What about the benefits?

According to numerous academic findings, HFT can have positive effects on market quality. In particular, it can contribute to price discovery and increased liquidity. As HFT responds to market signals quickly based on real-time information, it aids in quicker price adjustments and better accuracy for up-to-date valuations.

At the same time, a large number of buy and sell orders means more liquidity, making it easier for other traders to find available buy and sell orders. Considering this, HFT can be beneficial for all market participants.

Regarding fair trading, the question can be addressed by trading platforms implementing measures to ensure large trades can’t have a massive impact. Among such measures already integrated into platforms are order-size limits and frequency restrictions.

So, How Can You Execute High-Frequency Trading 

To start high-frequency trading (HFT), you need to understand the market and have a solid trading strategy. On the technical side, a fast internet connection and automated bots for processing large volumes of data are essential.

When deciding which market to trade in, each option has its advantages. 

Cryptocurrencies offer 24/7 trading opportunities and high volatility, which can create chances for big returns but also come with risks. Stocks, particularly blue-chip equities, provide liquidity but involve regulatory complexities. The forex market is the largest, but you need to take into account geopolitical factors and the aspect of increased competition.

What to choose depends on your risk tolerance, market knowledge, and technological capabilities.

FAQ

1. What Is High-Frequency Trading?

High-Frequency Trading (HFT) is a method of executing orders in a matter of milliseconds. HFT traders utilize AI bots, powerful computers, and other technological tools for this purpose.

2. Does High-Frequency Trading Impact the Market Negatively?

Opinions vary on this topic. Some studies suggest that HFT causes volatility and can potentially lead to market crashes, while others argue that HFT traders implement both buy and sell orders, which is unlikely to cause significant market fluctuations under normal conditions.

3. What Are Common High-Frequency Trading Strategies?

Common HFT strategies include liquidity provision, arbitrage, sniping, and others.

4. Are There Any Movies About High-Frequency Trading?

Yes, you can watch “The Hummingbird Project,” starring Salma Hayek, Jesse Eisenberg, and Alexander Skarsgård. This film follows two cousins who aim to gain a trading advantage in high-frequency trading, exploring the intense competition and ethical dilemmas associated with HFT.

Another option is “Money Bots,” a documentary featuring interviews with traders and industry experts that delve into how automated trading systems work and their impact on financial markets.