High-Frequency Trading: Everything You Need to Know

HFT… High Frequency Trading. What is it? Don't worry, hearing it in English probably causes you less fear. High-frequency trading or negotiation is a very famous strategy for trading in stock markets and it greatly affects stock exchanges and financial behavior. That's why in this post we are going to see everything you need to know about High Frequency Trading. We also bring you examples and real cases.

what is high frequency trading

History and Origins of High-Frequency Trading

High-frequency trading has been taking place at least since the 1930s, mainly in the form of specialists and pit traders who bought and sold positions in the physical location of the exchange, with high-speed telegraph service to other exchanges.

However, real high-frequency trading based on powerful computers gradually developed from 1983 after NASDAQ introduced a purely electronic form of trading.

Its evolution has been such that by the early 21st century, HFT transactions had an execution time of several seconds, while in 2010 it had decreased to milli and even microseconds. In fact, until recently, high-frequency trading was a little-known topic outside the financial sector, with an article published by the New York Times in July 2009 being one of the first to bring the topic to the public's attention.

On September 2, 2013, Italy became the first country in the world to introduce a tax specifically aimed at HFT, charging a levy of 0.02% on capital transactions that last less than 0.5 seconds

What is High-Frequency Trading (HFT)?

High-frequency trading (HFT) is a type of trading that takes place in financial markets using powerful computers and automated algorithms. Its main virtue is the speed of processing, allowing operations that last fractions of a second. Its goal is to capture in a very short time, a fraction of a cent in each operation. HFTs use little leverage (leverage) and do not accumulate positions. At most, they keep them from one day to the next.

When we talk about HFT, we are talking about volatility and the global correlation of markets. The latest volume estimate predicts that transactions on the stock exchange carried out by HFT in the United States account for around 65% of operations, while in Europe it is lower (around 40%).

How do high-frequency trades work?

The operation of an HFT is based on computers that buy and sell shares at a vertiginous speed. In some markets such as Nasdaq, they allow some traders to see the stack of orders 30 milliseconds before showing it to the rest. This allows them to take advantage of knowing what the immediate demand will be. With each HFT transaction, cents are earned, but this transaction is made millions of times a day. In the following image we can see one of the strategies used by HFT companies:

hft meaning

Another example of practices carried out by companies that use HFT would be the following:

Let's imagine an asset that is quoted on different Exchanges (NYSE, Tourquoise, and ChiX). When ChiX receives an order that is executed at a price (and remains incomplete), the HFT algorithms intuit that it will be completed on another platform such as Turquoise and/or NYSE. It is at this moment when the HFT “gets in the middle” anticipating buying the shares on another platform and placing an order to sell just before the initial order arrives, which will inevitably buy at the price offered by the HFT. The HFT takes a minimum difference.

HTF have the necessary power to receive the order when it arrives at Chix and transmit it to other markets, giving counterpart to the strong buy or sell order they know will arrive.

To avoid being harmed by this operation, large investors try to program their systems so that their orders arrive at the same time to all markets, thus avoiding that HFT can benefit from the latency of the orders.

It is assumed that HFT only has the information of the order when it arrives at a market, otherwise, they would be committing an illegal practice called “front running”.

High-Frequency Trade (HFT) Market Share

But, how much total influence do these high-frequency operating machines have on the market? Are their operations so high that they can influence the price of a stock? Unfortunately, the data seems to point to yes.

For 2009, in the US, high-frequency trading companies only represented 2% of the total operators, but with a 73% business volume

For 2010, the Bank of England estimated similar percentages for the market share of the United Kingdom, which also suggested an HFT share in Europe of around 40% of the volume of orders of equity and between 5 and 10% in Asia, with a potential for very rapid growth.

In 2012, according to a study by TABB Group, HFTs represented more than 60% of the total volume of US futures exchanges.

And as of 2020, approximately 50% of the trades that occur on the stock exchange are made by these high-speed machines. In fact, it is estimated that more than 20,000 companies already operate with this type of system.

So yes, we can affirm that their existence influences quite a lot in the quotation price of a company. And precisely because they influence a lot, we are going to see the main investment strategies that exist in high-frequency trading.

Main High-Frequency Trading (HFT) Strategies

As in any investment strategy, there are different techniques available with which to trade. And next, we will see the three most used techniques in HFT

Strategies for Operating with High Frequency Trading
Saturation Technique
Interference Technique
Deception Technique
News-based trading technique.

High Frequency Trading Strategies

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Saturation Technique

It consists of a series of companies (HFT) detecting that the market is going to receive an order to buy shares from an investor, then they send an avalanche of orders to buy the shares at a certain price and then be able to sell them a few cents above before the initial order of an investor is executed.

In this way, only those who operate faster will be able to take advantage of this price difference. That is, they anticipate the orders of the market and place them at a slightly higher price.

Interference Technique

It consists of sending an order and in the same millisecond eliminating this order. In this way, the Stock Exchange is confused with orders that are rarely executed.

This strategy has the objective of inducing error in the interveners, since the fact of having opened it, even if only for a millisecond, will give the market, and in particular, to small investors, the impression that volume is entering, which will motivate them to open new positions (if it fits with their strategy). So, by the time they realize that it was only an interference carried out by these machines, many traders will already be invested and trapped.

Deception Technique

It consists of pretending to buy shares and launching market orders, but the final intention is to sell (and vice versa).

News-based Trading

News of any listed company in electronic text format is available from many sources, including commercial providers such as Bloomberg, public news websites, and Twitter sources.

In this way, l automated systems can identify company names, keywords, and sometimes semantics to make news-based transactions before human operators can process the news.

I don't want to go into too much detail, but there are a lot of investment strategies based on HFT, including:

  • Quote stuffing
  • Ticker-tape trading.
  • Event arbitrage
  • Statistical arbitrage
  • Index arbitrage

Difference between latency and speed in HFT orders

Speed is measured in space/time, while latency is the time it takes from the order being transmitted to it being executed. Latency takes into account the “traffic lights”, the different intermediaries through which the order passes until it reaches its destination.

The Flash Crash of May 2010 caused by HFTs

The Flash Crash of May 6, 2010, was an unprecedented event in which the Wall Street Stock Exchange collapsed at a rapid pace, following a never-before-seen pattern. It was thought that this possible fall of the stock exchanges had its origin in the Greek crisis. The austerity measures adopted by the Greek government had provoked various altercations in the country (two people dying) so that, both the financial and political plane of Greece was terrible.

But the shock wave did not come from the European country. The US pension fund Wandell & Reed sold 75,000 contracts at an incredible speed as if wanting to get rid of those titles. He alone could not destabilize the market, all HFT companies were infected with the fear generated and began to sell at the microsecond level.

The debacle lasted no more than 14 minutes. The Chicago Stock Exchange stopped the collapse by interrupting the quotations for 5 seconds, it was a warning from the market indicating how far a stock market collapse can be produced with this type of practice. This phenomenon, in which the Stock Exchange collapses at a vertiginous speed, is known as a sudden drop or flash crash.

Companies that operate with high-frequency trading

Companies that operate with HFT use short and long positions simultaneously, launching limited orders at a slightly higher or lower market price depending on whether it is a sale or purchase. With this, they seek the safe benefit of the price difference and, for this, they need the entry time to the market to be immediate. They are experts in statistical arbitrage, looking for price discrepancies between the values of different classes of assets.

HFT operations perform the function of market makers or providers of them by creating supply and demand.

Some of the traders who trade the largest volumes through HFT strategies
Knight Capital Group
Getco LLC
Citadel LLC
Jump Trading
Goldman Sachs

Investigation for fraud against companies that used high-frequency trading

The FBI has opened an investigation into high-frequency trading companies for committing the crime of insider trading. The links between high-speed operators and major exchanges are being investigated, examining whether companies are receiving preferential treatment that puts other investors at a disadvantage.

For the FBI, the investigation constitutes a new way of using privileged information; speed. Patterns in the market are sought that may reveal if any of the trading activities violate the law. They will have to prove that these operations were carried out with fraudulent intent, which is much more complicated.

👉 This might be interesting: biggest investment scams in history.

HFT affects large investors or large orders in illiquid securities

In 2014, broker DeGiro conducted a study testing the SOR (system whose purpose is to reduce transaction costs for the end investor) used to send orders to different European exchanges. Checking that HFT firms are active in European markets, the Dutch platform prepared a report and found evidence that operators using high-frequency trading are benefiting from this order route at the expense of large investors or large orders in illiquid securities.

The broker pointed out:

That its analysis is in line with the ideas reflected in Michael Lewis's book, “Flash Boys: A Wall Street Revolt” where it is stated that high frequency operators take advantage of the speed of their systems, which give them milliseconds of advantage to overtake small investors in the execution of orders.

Other strategies you might want to check out:


What is a high-frequency bot?

It is the technology used to use high-frequency trading. Through the bot, operations are made in the different global markets instantly and with hardly any errors.

What is HFT Forex?

It is high-frequency trading that uses a type of super-advanced platform where multiple orders are sent to the foreign exchange market very quickly thanks to its powerful technology.

Is high-frequency trading profitable?

Yes, high-frequency trading can be profitable, leveraging advanced algorithms and speed to capitalize on market fluctuations. However, it requires significant technological investment and market expertise.

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