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High frequency trading strategies: High Frequency Trading Definition, Strategies, How it Works?


Plus, the use of algorithms means traders can spend less time monitoring markets themselves and make decisions based on rationality rather than emotions. The main advantage of high-frequency trading is that it enables traders to find profits from extremely small price movements. And geographic reach is also becoming more important as competition saturates established markets and exchanges. HFT firms are looking for fertile ground to plant their best strategy around the world where competition is less fierce.

Nasdaq’s disciplinary action stated that Citadel “failed to prevent the strategy from sending millions of orders to the exchanges with few or no executions”. On January 12, 2015, the SEC announced a $14 million penalty against a subsidiary of BATS Global Markets, an exchange operator that was founded by high-frequency traders. The BATS subsidiary Direct Edge failed to properly disclose order types on its two exchanges EDGA and EDGX. These exchanges offered three variations of controversial “Hide Not Slide” orders and failed to accurately describe their priority to other orders. The SEC found the exchanges disclosed complete and accurate information about the order types “only to some members, including certain high-frequency trading firms that provided input about how the orders would operate”.

Based on the collected data, the computers make automatic transactions. This is because the whole trade usually happens almost immediately, and there is no demand for high-market liquidity. Moreso, it also allows the users to exploit price changes before they fully appear in the order book. The trading style has been used in the stock and forex markets over the years and was recently extended to the crypto market. No opinion given in this material constitutes a recommendation by City Index or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

The report found that the cause was a single sale of $4.1 billion in futures contracts by a mutual fund, identified as Waddell & Reed Financial, in an aggressive attempt to hedge its investment position. While some firms exited the market, high-frequency firms that remained in the market exacerbated price declines because they “‘escalated their aggressive selling’ during the downdraft”. In the years following the flash crash, academic researchers and experts from the CFTC pointed to high-frequency trading as just one component of the complex current U.S. market structure that led to the events of May 6, 2010. In the early 2000s, high-frequency trading still accounted for fewer than 10% of equity orders, but this proportion was soon to begin rapid growth.

High-frequency traders typically compete against other HFTs, rather than long-term investors. HFT firms make up the low margins with incredibly high volumes of trades, frequently numbering in the millions. High-frequency trading is a type of algorithmic financial trading characterized by high speeds, high turnover rates, and high order-to-trade ratios that leverages high-frequency financial data and electronic trading tools. While there is no single definition of HFT, among its key attributes are highly sophisticated algorithms, co-location, and very short-term investment horizons. Specifically, it is the use of sophisticated technological tools and computer algorithms to rapidly trade securities.

Market manipulation

This has meant that typically HFT is used by institutions that have access to the required equipment – such as investment banks and hedge funds. High-frequency trading, or HFT, is a strategy that involves executing a large number of orders quickly – within seconds. The aim is to capture a small amount of profit, sometimes a fraction of a cent, on each trade. HFT strategies have also been broadened out of equities to more asset classes including foreign exchange , ETFs and from new corners of the market such as commodities trading advisors, she added. Now, the firms that remain have become some of the biggest market makers. In the first decade of the 2000s, armed with degrees from top universities, ambitious, aspiring Wall Street climbers flocked to HFT to open their own firms.


Regulators should address market manipulation and other threats to the integrity of markets, regardless of the underlying mechanism, and not try to intervene in the trading process or to restrict certain types of trading activities. Risk controls were poorer in high-frequency trading, because of competitive time pressure to execute trades without the more extensive safety checks normally used in slower trades. Much information happens to be unwittingly embedded in market data, such as quotes and volumes.

The strategy that engages powerful computers and servers and the fastest connectivity technology to trade large numbers of orders at extremely high speeds. In July 2013, it was reported that Panther Energy Trading LLC was ordered to pay $4.5 million to U.S. and U.K. Regulators on charges that the firm’s high-frequency trading activities manipulated commodity markets. Panther’s computer algorithms placed and quickly canceled bids and offers in futures contracts including oil, metals, interest rates and foreign currencies, the U.S. In October 2014, Panther’s sole owner Michael Coscia was charged with six counts of commodities fraud and six counts of “spoofing”.

The common types of high-frequency trading include several types of market-making, event arbitrage, statistical arbitrage, and latency arbitrage. Most high-frequency trading strategies are not fraudulent, but instead exploit minute deviations from market equilibrium. The firms engaged in HFT often face risks related to software anomaly, dynamic market conditions, as well as regulations, and compliance. One of the glaring instances was a fiasco that took place on August 1, 2012, which brought Knight Capital Group close to bankruptcy. It lost $400 million in less than an hour after markets opened that day.

Prior to the Volcker Rule, many investment banks had segments dedicated to HFT. Post-Volcker, no commercial banks can have proprietary trading desks or any such hedge fund investments. Many of the regular broker-dealer firms have a sub-section known as proprietary trading desks, where HFT is done. This section is separated from the business the firm does for its regular, external customers. Let’s explore some more about the types of HFT firms, their strategies to make money, major players, and more. Regulators all over the world have some concerns about how this technology can be used to manipulate the market, especially because top-tier traders can get a speed that no other traders can have.

Pros and Cons of High-Frequency Trading

The impetus for efforts to modernise the securities markets was detailed in an opinion to the SEC’s approval vote for Regulation National Market System . HFT was developed and took hold after 2005, when the SEC took efforts to modernise the securities markets. “Report examines May’s ‘flash crash,’ expresses concern over high-speed trading”. This supports regulatory concerns about the potential drawbacks of automated trading due to operational and transmission risks and implies that fragility can arise in the absence of order flow toxicity. Quote stuffing occurs when traders place a lot of buy or sell orders on a security and then cancel them immediately afterward, thereby manipulating the market price of the security.

Other complaints against HFT include the argument that some HFT firms scrape profits from investors when index funds rebalance their portfolios. The fastest technologies give traders an advantage over other “slower” investors as they can change prices of the securities they trade. Another source of income for HFT firms is that they get paid for providing liquidity by the Electronic Communications Networks and some exchanges. HFT firms play the role of market makers by creating bid-ask spreads, churning mostly low-priced, high-volume stocks many times in a single day.

electronic trading

Although the role of market maker was traditionally fulfilled by specialist firms, this class of strategy is now implemented by a large range of investors, thanks to wide adoption of direct market access. A substantial body of research argues that HFT and electronic trading pose new types of challenges to the financial system. Algorithmic and high-frequency traders were both found to have contributed to volatility in the Flash Crash of May 6, 2010, when high-frequency liquidity providers rapidly withdrew from the market. Several European countries have proposed curtailing or banning HFT due to concerns about volatility.

The most common and biggest form of HFT firm is the independent proprietary firm. Proprietary trading(or “prop trading”) is executed with the firm’s own money and not that of clients. By exploiting this speed, traders explore an imbalance between supply and demand to strike at the right second and get profit while barely holding the assets for much time. High-frequency trading uses specialized software and expensive computer hardware to analyze the market trends.

May 6, 2010 Flash Crash

Politicians, regulators, scholars, journalists and market participants have all raised concerns on both sides of the Atlantic. This has led to discussion of whether high-frequency market makers should be subject to various kinds of regulations. Company news in electronic text format is available from many sources including commercial providers like Bloomberg, public news websites, and Twitter feeds. Automated systems can identify company names, keywords and sometimes semantics to make news-based trades before human traders can process the news. These strategies appear intimately related to the entry of new electronic venues. Academic study of Chi-X’s entry into the European equity market reveals that its launch coincided with a large HFT that made markets using both the incumbent market, NYSE-Euronext, and the new market, Chi-X.

It involves quickly entering and withdrawing a large number of orders in an attempt to flood the market creating confusion in the market and trading opportunities for high-frequency traders. A trader is someone who engages in the purchase or sale of assets in any financial market, either for themself or on behalf of another party. Proprietary trading refers to a financial firm or bank that invests for direct market gain rather than earning commissions and fees by trading on the behalf of clients. Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate.

Prableen Bajpai is the founder of FinFix and Analytics Private Limited. She has 10+ years of experience as a finance, cryptocurrency, and trading strategy expert. Many blamed the 2010 Flash Crash on HFT strategies, and some even believe that it leads to unhealthy markets.

What is high-frequency trading?

Unlike traditional traders, HFT gains can go down as quickly as they went up. It is done mostly by large organizations always trying to end a day without actually holding assets. Although there have been calls to ban HFT practices, it hasn’t happened yet. The method itself isn’t inherently manipulative or fraudulent – according to the CFA Institute – but it does increase the likelihood that firms will engage in manipulative and fraudulent activities.

An example is the New York Stock Exchange’s Supplemental Liquidity Providers group which receives rebates for adding competition to the market. High-frequency trading is a practice used to execute large orders quickly and take advantage of market inefficiencies. Learn about high-frequency trading strategies, as well as the benefits of HFT and its criticisms. The events reverberated through markets, Wall Street and business circles, and Lewis’ book ̶ a New York Times #1 best-seller ̶ blared that markets were tilted to favour HFT’s to the detriment of mom and pop retail investors. Outside of US equities, several notable spot foreign exchange trading platforms—including ParFX, EBS Market, and Refinitiv FXall—have implemented their own “speed bumps” to curb or otherwise limit HFT activity.

Tracking important order properties may also allow trading strategies to have a more accurate prediction of the future price of a security. Another set of high-frequency trading strategies are strategies that exploit predictable temporary deviations from stable statistical relationships among securities. Statistical arbitrage at high frequencies is actively used in all liquid securities, including equities, bonds, futures, foreign exchange, etc. High-frequency trading allows similar arbitrages using models of greater complexity involving many more than four securities. Merger ArbitrageMerger Arbitrage, also known as risk arbitrage, is an event-driven investment strategy that aims to exploit uncertainties that exist between the period when the M&A is announced and when it is successfully completed.

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