What is High-Frequency Trading? | Definition & examples


High-frequency trading (HFT) involves the use of sophisticated computer algorithms to execute a large volume of transactions in financial markets at lightning-fast speeds. These algorithms continuously monitor multiple markets and swiftly execute trades as opportunities arise. In HFT, the ability to execute trades quickly is paramount for profitability, with faster traders gaining a competitive edge over slower ones.

High-frequency trading in a nutshell

  • High-frequency trading (HFT) utilizes complex algorithms for lightning-fast transactions in financial markets.
  • Algorithms monitor multiple markets, swiftly executing trades based on identified opportunities.
  • HFT traders employ computer software and AI to automate trades, executing large orders in split seconds.
  • High-frequency trading platforms include Pocket Option, Quotex, and IQ Option, offering efficient trading opportunities with varying features.

High-frequency trading explained

High-frequency traders use computer software and artificial intelligence (AI) to automate trades. When it comes to identifying investment prospects, this strategy uses algorithms. Big trading orders may be performed in a split second.

Official logo of the US. Securities and Exchange commission (SEC)

To standardize this form of trading, the Securities and Exchange Commission (SEC) came up with the following list of characteristics:

  • Orders are generated, routed, and executed with the help of very fast and efficient software.
  • Private information flows from exchanges and others may be used to reduce networking and other delays.
  • Positions may be formed and liquidated in hours rather than days or weeks.
  • Several orders are submitted but are subsequently canceled.
  • Aiming to conclude the day with a feasible flat position (that is, not carrying significant, unhedged positions overnight).

What are the benefits of high-frequency trading?

As a result of high-frequency trading, bid-ask spreads that were previously too low have been eliminated. It was put to the test by increasing fees on high-frequency trading (HFT), which caused bid-ask spreads to rise. 

According to one piece of research, Canadian bid-ask spreads were altered when the government imposed fines on high-frequency trading (HFT). Bid-ask spreads climbed by 13% throughout the market, while retail spreads surged by 9%.

An example of high-frequency trading

High-frequency trading helps investors take advantage of short-term stock market prospects. Their early access to new possibilities means they may benefit before the market reacts.

For instance, a large investment business decides to liquidate a portion of its holdings. This deal involves around 1 million shares of Company X’s stock. In this scenario, the price per share of Company X is expected to drop for a brief period while the market adjusts to the new stock offerings. This drop might linger for minutes or even seconds, giving an algorithm enough opportunity to place several transactions while most human traders are distracted.

Exploring some common things about high frequency trading

If you are looking for a formal definition of this form of trading, then you should keep in mind that the SEC – Securities and Exchange Commission doesn’t roll out a proper definition on this. However, the authority has attributed some features to it that you should consider. 

  • It involves advanced, sophisticated, and high-speed programs to route, execute or generate different trade orders. 
  • The trading practice utilizes huge individual data and co-location services provided by different exchanges and others to lower the latencies and network issues so that the traders can enjoy a smooth HFT trading experience.
  • The time frame to establish and liquidate the positions can be very short.  
  • It involves the practice of submitting different canceled orders. 
  • As per the rules, the trading day should be closed to a flat position. 

For those who don’t have sufficient knowledge about this, high-frequency trading can be very difficult. Why? As discussed above, such a type of trading requires better infrastructure and software. Besides, the traders should have a proper understanding of the market.

That’s why this market is generally dominated by hedge funds as well as large firms. Still, wondering Can anyone do high-frequency trading? Well, it will depend on your level of knowledge and skills. Besides, there are some other factors to consider. Have a look at the below-listed sections. 

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Is high-frequency trading profitable?        

Some people will say it is highly profitable as you can earn a decent amount of profit within a few seconds. But some also say it is very risky, and if something goes wrong or you fail to manage this properly, you can lose all your invested money. 

If HFT depends on the low latency, then it’s all about the speed. As a trader, you need to offer liquidity at first or at some level to make some profits. Well, if you may have any delay, then you may lose around 80 percent of the total edge. In the case of third, then you will lose more. The thing is that it is a zero-sum game. Technology is evolving rapidly, and the competition is now intensifying. And the winner can be only one. This type of trading is quite expensive, and margins are also very low. 

Now talking about the positive side, with High-Frequency Trading, you can earn more profits quickly. As per the experts, one can dominate a market worth of trillion dollars just by using a hundred million or less. The leverage costs are very less and compared to the profit factors, you may find the risk is low. 

In general, those who can execute the trades faster can be more profitable compared to the HFT traders who execute slowly. Apart from the speed, order to trade ratios and turnover rates will also play a great role here. So, is high frequency trading profitable? The answer will vary from one person to another. 

How common is high-frequency trading?

Wondering How common is high-frequency trading? Well, considering all the latest news and reports, it can be said that this trading is very common. The major reason behind this is that trading depends on technology and data. They can react much more quickly as they generally use algorithms and automated trading that allow them to study the market and execute them within a few seconds.

It started during the 2000s, and after that, it witnessed massive popularity. It can be said that currently, it represents more than 40 percent of the total trading volume in the United States of America’s equity market. In the case of the European market, the share range from 24 percent to 43 percent. So, this is gaining popularity. Besides, the trading format is regulated properly.

Regulation of high-frequency trading

This has some well-known governing regulations from different regulators. For example:

ESMA

MiFID II- Markets in Financial Instruments Directive II of ESMA has made it clearer and more transparent to understand this market. For example, all the investors have certain exemptions, and all the activities should be properly authorized by financial authorities. On the other hand, every investor should keep a time-sequenced record of the trades, algorithms, and system for around five years. So, this will prevent the illegal use of the market. 

FINRA

The financial market in the United States of America is controlled by the FINRA– Financial Industry Regulatory Authority. It also issued some rules for this trading. And the new rules have restricted the firms the way they used to conduct the transactions, lowering the chances for improper influence, fictitious quoting, spoofing, and more

The regulators have made it mandatory for the firms to test the market before implementing any offer, and they all should follow a risk management standard. 

This has created the trust factors that people need to enter into this market. Supported by the latest technologies and better regulations and rules, this market is now getting more common in the global financial market. 

Can anyone do high-frequency trading?   

One of the most common questions among HFT traders is, Can anyone do high-frequency trading? This form of trading is not suitable for people who don’t prefer to take any risk. If you are ready to take a risk and understand what can happen if things go wrong, then HFT is for you. However, you can make your chances to play well in this form of trading by applying the right strategies. To help you out with this, we have listed some major strategies for you. 

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#1 Order flow prediction strategy

Here you will predict the orders of major players in different ways. After that, you can trade a position a little higher than that to make a profit. 

#2 Execution strategies

This strategy will help the traders to execute large orders of different major institutional players without creating a major price impact. This can include: 

  • Volume-Weighted average price strategy: Using this, you can execute large orders at a profitable average price. The ratio of the traded value may vary. 
  • Time-Weighted average price strategy: Traders use this to buy and sell large shares blocks without affecting the trade price. 
Price-Action-strategy

#3 Liquidity provisioning strategy

The traders need to establish the right quote, and then they should update that continuously based on the other traders’ cancellations or submissions. Such a form of continuous updating of the trade quote can be done considering the trade model followed by the Market-Maker. Under this process, the market-makers submit and cancel massive orders for each transaction.

#4 Automated strategies

The Arbitrage strategy captures a small amount of profit when there is a huge price differential results between the instruments. As per the experts, Index arbitrage is considered an ideal example. The price movement between the S&P 500 futures as well as SPY should move parallelly. 

If the movement of prices varies, then the trade’s index arbitrageurs will try to capture the profits as soon as possible, deploying the is particular strategy. In order to perform this properly, you need to focus on rapid execution to maximize their gains quickly.

Consider all these things, and you can safely trade in this type of trading. And it will be possible for you to make a profit from it. 

Is high-frequency trading fair?      

To understand this, you should focus on two major things. These are: 

1. Does It hurt the financial market?

As most trading utilizes computer systems, people may think that it will be easy for them to have a look at the practices that the traders perform. However, some companies can falsify the trading activities, and as it involves a large amount of data, it will make it challenging to get a clear picture. You can take the example of the incident that happened in 2010.

All the major indices went up around 6 percent within a few minutes but then rebounded very quickly. Some companies’ shares were traded at a price 60 percent more than their actual value. However, to deal with such an unwanted situation, the SEC – Security Exchange Commission deployed a circuit breaker that brings the rule to pause the trader of a certain stock moves down or up by 10 percent. So, now you can witness a fair-trade practice in the market. 

2. Does It hurt retail investors?

One of the most important things that every trader should know about High Frequency Trading is how it can influence the retail investor. However, there is nothing to worry about it as the market follows 100 percent transparency, and one can see the transactions in real-time. 

So, there is nothing wrong with High Frequency Tradingand you should prefer to try out this trading but make sure that you have a proper understanding of this. 

Will high-frequency trading be banned?   

As per some studies, HFT trading is considered a controversial activity. Besides, you may not find it that popular among scholars, regulators, and finance professionals compared to other types of trading. Most of the traders don’t prefer to keep the portfolios overnight. They establish holding for a limited time period before they can liquidate the position. 

Even though HFT is much riskier than other forms of trading, there is no such law or rule that says about the ban of HFT trading. So, you can go for such trading without any worries. But it will be better for you to understand its pros and cons so that you can decide whether you should choose this or not. 

The pros of high-frequency trading

To attain success in arbitrage, they need to be much faster than others, and that is a major reason behind the increasing speed. Well, there are multiple benefits that this form of trading can offer to individual and institutional traders. However, some of the major benefits are:

It offers large trades

A major benefit of choosing HFT trading is that such a form of trading allows the investors to deal with large positions. Under this form of trading, you can divide your trade orders into small parts. And the best thing is, as you will make small trades, it will have a much smaller impact on the cost. As a result, the market impact and transaction costs will go down. 

Better liquidity

There is no doubt that high-frequency trading share is quite considerable. On the other hand, the HFT algorithms create a significant liquidity share by applying passive market-making methods. Such strategies can lower the spread of sell and buying prices. Furthermore, it also increases the secondary market’s depth. Such factors are quite crucial for potential investors as to when there is a better rate of liquidity; it will make them feel highly confident while trading more. 

Price volatility and valuation

HFT needs a good level of volatility to get better returns. This form of trading lowers the deviation of the assets from its medium. And for long-term investors, this can be very attractive. Why? For them, this will lower the risk of buying assets at the wrong price. On the other hand, the markets’ efficiency will grow with fairer prices and faster valuation created by HFT. However, you should keep in mind that irrational investors may deal with penalties if they choose this form of trading. 

It promotes competitive and open markets

The use of advanced technologies lets the small players confidently compete with different large banks. In fact, it will be much easier for all the smaller players to enter this evolving market. 

It will bring new opportunities and new methods

It has been seen that the advanced HFT algorithms have enabled the traders to explore different strategies. Some experts think that such type of variation can offer the desired sustainability and flexibility to the market. On the other hand, it can offer real-time responses about the changes in the market. 

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The cons of high-frequency trading 

You may find some people who will disagree with the benefits that the trading offer. They say this can develop a catastrophe for the global financial system. Well, the market has not witnessed such a situation yet, but you should know about some cons of HFT. 

Fake liquidity and market manipulations

Well, the stock exchange’s advanced infrastructure allows different types of trading strategies to earn money. The field includes carrying out large trading orders through institutional investors. HFT, as it includes advanced technology and a computing system, can easily track those orders. After that, they try to absorb the liquidity. As a result, they will be forced to close positions to the big investors. So, for the institutional investors, the cost can be more. 

On the other hand, sometimes, people may face spoofing. When the traders get some shares, they can try to increase the cost by making purchase orders. And they do that to attract other buyers to sell them the shares at a higher price than they have purchased at a lower rate.

The maintenance cost can be more

Can anyone do high-frequency trading? The HFT algorithms require better processing powers. To keep it smooth, the exchanges that are involved in this need to constantly update their cables, equipment, and working structure. So, if you don’t have a sufficient budget for all these things, then HFT is not for you. 

Most of the traders ask, is high-frequency trading profitable? The answer can be yes or no. With time, the trading procedures and the equity markets are changing rapidly. And the most significant change is speed transactions. However, this also has increased the risk level in the market. So, it is advisable to analyze your risk profile first. Some experts have suggested that this trading is an ideal example of the rapid transformation of the global financial markets. 

Pros of High-Frequency Trading
  • Offers large trades
  • Better liquidity
  • Price volatility and valuation
  • Promotes competitive and open markets
  • Brings new opportunities and methods
Cons of High-Frequency Trading
  • Fake liquidity
  • Market manipulations
  • Maintenance cost can be high
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Can you do High-Frequency Trading with Binary Options?

Yes, you can engage in High Frequency Trading (HFT) with Binary Options, leveraging advanced algorithms and rapid order execution. HFT uses complex software to capitalize on market conditions and short-term trends to make quick profits. This strategy, which is used by both institutional and retail traders, offers real-time data, minimal latency and fast trade execution.

Although HFT is legal, it has been criticized because it can increase market volatility, and it requires compliance with regulatory standards to avoid illegal practices such as price stuffing.

Top 3 High-Frequency Trading Trading Platforms

When it comes to high-frequency trading platforms, these three stand out:

  • Pocket Option: Best for efficient HFT trading with a user-friendly interface.
  • Quotex: Known for reliable trading signals and global accessibility.
  • IQ Option: Excellent choice for beginner-friendly HFT trading with comprehensive educational resources.

Conclusion – High-Frequency Trading has its ups and downs

According to advocates of high-frequency trading, it helps markets find stable, efficient values quickly. Retail investors, say these proponents, lack the time and resources to take advantage of these possibilities.

High-frequency trading, on the other side, is regarded as a market distortion. Because of the quicker pace at which institutional investors may execute trade orders, they can influence the market to respond to transactions centered more on algorithmic trading methods than on market prices.

About the author

Percival Knight
Percival Knight is an experienced Binary Options trader for more than ten years. Mainly, he trades 60-second trades at a very high hit rate. My favorite strategies is by using candlesticks and fake-breakouts

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