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What is High-Frequency Trading (HFT)?

Redwan Eid | Jul. 15, 2019
What is High-Frequency Trading (HFT)?

High-frequency trading – HFT is a term used in talks that involve cryptocurrency exchanges and trading on them. It is a program trading platform where the speed of procedure is the beginning, the core and the end of the transaction.

July 15, 2019 | AtoZ Markets - The program uses high-powered computer to process a large number of orders in nanoseconds, depending on complex algorithms to analyze multiple markets and execute orders based on market conditions.

This means the faster the execution speed is, the more profitable it is.

Studies and experiments show that the HFT system has improved market liquidity and removed bid-ask spreads that previously would have been too small. This was proven by adding fees on HFT, and as a result, bid-ask spreads increased.

The system spread when exchanges started to offer incentives for companies to add liquidity to the market.

How does high frequency trading make money?

To simplify the gist in abbreviation, HFTs are buying at a lower low price and selling when the price is above trend.

This helps in reducing the price fluctuations. When they are successful, prices look like the blue line on the chart, with the blips are smaller and shorter-lived.

Investors earn from the spread between the price at which they buy (the “ask” price) and the price at which they sell (the “bid”). Here we have a term called “the bid-ask spread”, which compensates the market makers for executing trades at exactly the time waned for trading.

Volatility of stock price here plays in favour of the investor, meaning, the more the price volatile is, the broader the bid-ask spread is.

As for the tech part, placing trading servers physically close to exchanges’ matching engines will make a difference in the processing speed, and that is another factors HFT usually play on to make bigger profits.

As a practical example, we can look at the New York Stock Exchange (NYSE), which has a group of liquidity providers called Supplemental Liquidity Providers (SLPs).

The above-mentioned system was introduced not long after the collapse of Lehman Brothers in 2008, when liquidity was a major concern for investors.

SLPs attempts to add competition and liquidity for existing quotes on the exchange. As an incentive to companies, the NYSE pays a fee or rebate for providing said liquidity.

It was mentioned that in July 2016, the average SLP rebate was $0.0019 for NYSE- and NYSE MKT-listed securities on NYSE, benefiting of the millions of transactions done a day with large amounts of profits.

What do high frequency traders do?

High frequency traders try play in the area of price movements caused by large institutional trades.

When a mutual fund sells one million shares of a stock, the price decreases. High frequency traders exploit the moment and buy then, hoping to be able to sell the shares a few minutes later at the normal price.

When a pension fund buys two million shares, high frequency traders short-sell the stock, in hope to close their position at a profit. (Short selling is the process of selling a stock you do not own; you borrow the shares from a stockbroker for selling them, and then later buy the stock to return the borrowed shares.)

Is high frequency trading legal?

There is no official regulatory text that declares high frequency trading is illegal. As it is allowed to be practice, then this means it is legal, in theory for now for sure.

For delegalising HFT, there should be legitimate reasons.

What percentage of trades are high frequency?

As per estimates and records by the industry specialists over the web, high-frequency trading accounted for 52 percent of May’s average daily trading volume of about 6.73 billion shares.

Crypto data in 2009 unveiled that about 61 percent of 9.8 billion of average daily shares traded were executed by high-frequency traders.

Disclaimer: The views and opinions expressed in this article are solely those of the author and do not reflect the official policy or position of AtoZ, nor should they be attributed to AtoZMarkets.