What is High Frequency Trading

High-frequency trading is a unique form of algorithm trading that involves managing a large number of orders at a very high speed. The traders in HFT algo trading are done by experts who use sophisticated algorithms and computer systems. In HFT, complex algorithms are used and are executed on orders based on market conditions. This form of trading is mostly used by institutional traders to hedge funds and capitalize on small price changes. In this blog, we will explore what is high frequency trading, how high-frequency trading works, its advantages, disadvantages, and a lot more. 

What is Algorithmic Trading?

An algorithmic trade is a process of executing orders at high speed in the financial market using pre-programmed trading instructions. Based on time, volume, and price, investors and traders feed software trading instructions. As soon as the set instructions are triggered in the market, the software executes the orders. Most hedge funds, mutual funds, insurance companies, banks, etc., use algorithmic trading to execute huge volumes of trades. 

How does High Frequency Trading Work?

High-frequency trading depends on two major aspects: speed and efficiency. The firms that are engaged in high-frequency trading use algorithms to find trading opportunities. Advanced technology and high-level algorithms are used to detect patterns, trends, and price inefficiencies. When a possible profit has been detected the automated trading algorithms can easily complete the trade generally in microseconds, taking advantage of even a minor change. HFT algo trading is mostly used by banks, financial institutions, and institutional investors. 

Strategies of High-Frequency Trading

Market making, quote stuffing, tick trading, and statistical arbitrage are some high-frequency trading strategies. Let's take a closer look at HFT strategies.

• Market Making: Normally, this is a company or investor who is willing to buy and sell shares at a public price regularly. In many HFT firms, market-making is an effective strategy. Using HFT strategies, limit orders are placed to sell or buy stuff.
   
• Quote Stuffing: The goal of this HFT strategy is to create confusion. By buying and selling large numbers of orders rapidly, high-frequency traders try to gain market share. This confusion leads to a surge in trading volume, which gives high-frequency traders profitable opportunities to start multiple trades at the same time.
   
• Tick Trading: The tick trading process involves powerful computers. As market data and trading volumes flow, the computers track the quotes and market information. A tick trade is usually used to mark the beginning of a large order.
   
• Statistical Arbitrage: In this type of arbitrage, various securities are priced differently across multiple markets or exchanges. It is used in liquid securities like bonds, stocks, currencies, futures, etc. 

Advantages of High-Frequency Trading (HFT)

There are several advantages to HFT as mentioned below.

• HF traders can make quick profits: With HFT, investors can make quick profits by executing many trades at the same time. Despite price fluctuations, a bid-ask spread can give investors a lot of capital. 
   
• It opens up more opportunities: A high-frequency trader uses powerful computers and software to scan multiple markets at once. This lets investors identify arbitrage opportunities and profit by buying on one exchange and selling on another.
   
• HFT enhances liquidity in the market: With increased competition and volume, HFT decreases the bid-ask spread, resulting in more efficient prices. Additionally, as liquidity increases, the market becomes more transparent, flexible, and less risky.
   
• A lower chance of human error: When trading, humans can make mistakes or enter or exit at the wrong time. However, the benefit of HFT is that it avoids the interference of humans. Moreover, humans cannot execute such a high volume of orders at the speed of HFT. 

Disadvantages of High-Frequency Trading

The following are the disadvantages of high-frequency trading.

• Difficulty in Monitoring: It is a challenging task to monitor and regulate HFT due to its complex algorithms and software. It is also a controversial topic, as scholars and finance professionals have little agreement on HFT. 
• Criticism of High-Frequency Trading: Generally, HFT gets criticized because it replaces lots of brokers and dealers with software. Also, it's considered a bad process since investing most of the time requires human intelligence.  
• Increased Trading Costs: There can be an increased trading cost for others. As HFT algo trading firms make profit from narrow spreads and market-making. They can push up the costs of trades for slower participants, such as retail investors or smaller institutions.
• Market Instability: Since HFT trades quickly, it may cause sudden capital movements. This can lead to an increase in market instability. 

Conclusion 
Employing highly developed technologies and specialized techniques to undertake trade at an unprecedented velocity, also known as High-Frequency Trading, has become the new face of today’s global financial markets. HFT meaning is the system in which a large number of transactions are executed with the help of better software and algorithms while working. High-frequency trading  is available through a great online trading app. Some of the benefits associated with such markets include; quick returns, enhanced market flexibility, and the elimination of the human factor. On the same note, however, it has some demerits as we have seen that include the challenges of monitoring and regulating HFT, and the criticisms that accompany the lack of human touch in investing among other factors that contributed to market volatilities.