When exploring the world of algo trading, most traders come across the term “high-frequency trading” (HFT). Companies that deal with HFT are said to account for about 50–60% of US equities trading volume, and the names of such firms are associated with high returns and success. So, what is high-frequency trading, and what enables its inherent speed and high turnover rates? What can common traders learn from high-frequency traders so that they don’t become their prey? Let’s find out all about HFT trading.

What is high-frequency trading (HFT)?

Basically, HFT is a type of algorithmic trading associated with high speed, high turnover rates, and short portfolio holding periods. HFT traders use powerful computers to execute dozens of orders within milliseconds. They usually trade in small lots to test the market, often operating in dark pools, so you can never know whether you are trading against a high-frequency trader. And — last but not least — high-frequency traders are often behind flash crashes and the subsequent skyrockets a few seconds later.

HFT blamed for May 6, 2010 Flash Crash

Many people believe that HFT contributes to market fragility, while others call it the locomotive of market liquidity. Is HFT good or evil? Well, the case of the May 6, 2010 Flash Crash made thousands of people believe high-frequency traders are manipulators of the financial market.

That day, the US stock market experienced a flash crash that wiped billions of dollars off the share prices of large US companies like Procter & Gamble and General Electric. The report from SEC and CFTC stated that it was partly the result of a large automated sell order. It all started with a mutual fund, identified as Waddel & Reed Financial, that made a single sell of $4.1 billion in futures. High-frequency traders, according to the report, “quickly magnified the impact of the mutual fund’s selling.”

However, some other organizations, like CME, argued that HFT was not to blame, as it actually stabilized the situation and minimized the flash crash.

High-frequency trading expanding to the cryptocurrency market

HFT accounts for more than 70% of orders on the US stock market and is now coming to crypto exchanges. To enable high-frequency trading, an exchange needs to offer colocation facilities, which means the trader’s server is placed in the same facility or cloud as the exchange’s.

“This phenomenon has occurred in other asset classes as trading has become more electronic and more automated. Market makers and arbitrageurs are able to trade more efficiently, which improves price formation, price discovery, and liquidity. Arbitrage opportunities may become fewer and more fleeting, which is a sign of a more efficient and maturing market.”

Matt Trudeau,
CSO ErisX

Bots have been present in crypto for a long while, but colocation brings algo trading to a whole new level. In the list of exchanges that offer colocation services, there are Xena Exchange, Huobi, Gemini, and ErisX. Huobi, for example, stated that one of its clients makes about 800,000 trades a day using colocation. So, HFT trading is now expanding to crypto.

“We offer a tier-4 data center in Luxemburg to provide our clients with colocation facilities. In practice, that means that traders who use colocation will be able to trade up to 100 times faster than other users.”

Alexey Semichastnov,
CPO Xena Exchange

HFT benefits and drawbacks

High-frequency trading has been on traditional markets for several decades and has always been considered a controversial practice.

Advantages Disadvantages
  • enhances liquidity
  • increases the volume of trades
  • reduces bid-ask spread
  • makes markets more price-efficient
  • increases market volatility
  • results in profiting at the expense of smaller players on the market
  • sometimes causes illegal market manipulations like spoofing and layering

Spoofing and layering are automated trading activities initiated to outpace other market participants for manipulation. Spoofers create the illusion of the supply or demand of an asset by putting many limit orders on one side so that it seems there’s pressure to buy or sell. Layering means that many orders are created and then canceled by a trader in order to make the price grow or decline.

High-frequency trading strategies

High-frequency traders never stick to a single strategy and instead use multiple techniques. As high-frequency traders never hold a single asset for a long time, they are constantly making new portfolio-allocation decisions using algorithmic models. The success of such models mostly depends on whether they can simultaneously process large volumes of data. Most techniques consist of several arbitrage strategies executed at lightning speed and market-making.


Different types of HFT strategies

  • Investor
  • Trader (speculator)
  • Trader (arbitrageur)
  • Hedger
  • Market Maker
  • Execution HFT strategies
  • Order flow prediction HFT
  • Automated HFT arbitrage
  • Execution HFT strategies
  • Automated HFT market-making

Execution HFT strategies aim to execute the large orders of institutional players while causing no or little price impact. These include volume-weighted average price (VWAP) to execute orders at a better average price and time-weighted average price (TWAP), which is used to buy or sell assets without affecting the price.

Order flow prediction HFT strategies try to predict the orders of large players in advance, take trading positions ahead of them, and lock in the profits as a result of the subsequent price impact from the trades of the large players.

Automated HFT arbitrage strategies try to capture small profits when a price difference occurs between two similar instruments.

HFT market maker strategies are required to establish a quote (the most recent price at which some amount of the asset was transacted) and to update it continuously.

In 2016, a study called “A Survey of High-Frequency Trading Strategies” was published by Brandon Beckhardt, David Frankl, Charles Lu, and Michael Wang. If you’d like to dive deeper into HFT trading strategies, we highly recommend reading this survey.

High-frequency trading software

There are several ways traders can access HFT, including by finding a broker and by owning a powerful computer and installing some good software. There are several software providers on the market, but before buying pretty expensive software, it’s worth considering your next steps.

  1. You should have a trading strategy in mind, as no software provider will sell you a high-frequency trading strategy, algorithm, or signals.
  2. HFT trading is associated with high infrastructure costs: collocated servers, high-speed data providers, brokerage fees, etc.
  3. HFT software is not plug-and-play, so you need to adjust many things before placing your first order.

HFT is common in the financial markets

High-frequency trading is efficient and thus common in the financial markets. Institutional investors spend billions of dollars on the development and implementation of HFT strategies every year. HFT is expanding to new markets like the cryptocurrency market and gaining more coverage in the media. Ordinary traders have to deal with this power on the market and avoid the traps it sometimes creates.

On our blog, we publish many educational articles that help traders become more efficient on the market and recognize trap patterns. For those who use high-frequency trading techniques, we have a tier-4 data center in Luxemburg with colocation facilities.

Want to know more about algo trading?

If you’d love to learn more about algo trading, we have something to share on our blog. Read the following stories to get a better understanding of algo trading: