HFT Trading – Everything You Need to Know
For the past two or three decades, the use of high-frequency trading has been significantly increasing. According to estimates, HFT trading volume reaches 50% of the total volume on world exchanges. While those who use this trading strategy believe it benefits financial markets and contributes to high liquidity, many traditional traders oppose the method, claiming it creates unfair competition.
What is HFT (Algorithmic) Trading?
High-Frequency Trading (HFT), also known as Algorithmic trading/automated trading/black-box trading, is an algorithmic trading method that performs transactions (mainly in securities and financial assets) through high-frequency orders automatically. HFT trading companies invest a huge amount of capital and resources in technology and high-speed communications to enable the flow of orders more quickly than their counterparts and utilize this speed to make profits on different stock exchanges.
The use of HFT trading has been significantly increasing in recent years, and it is estimated that the volume share of HFT machines and traders now reaches 50% of the total volume of trading on the world’s stock exchanges.
Spread Networks is a famous company that provides hyperspeed connections for financial firms engaged in high-frequency trading to stock markets. In 2010, this company developed a fiber route from Chicago to New York to reduce the latency, which eventually creates algorithmic HFT profits for the company and its customers.
HFT Trading – Why is it Important?
The advocates of HFT trading believe it has a major contribution to capital market liquidity, lowering trading costs and increasing market efficiency. Further, the contribution of HFT trading includes the elimination of price anomalies and, therefore, a more competitive and tradable market.
On the other hand, those who criticize HFT trading activity simply claim that the market is not equal. One of the first people to point out about this phenomenon is the author Michael Lewis who claimed in his 2014 book Flash Boys: “The market is rigged.”
HFT trading companies invest large amounts of capital in telecommunications technologies, such as fiber optics, so that financial information goes all the way from the stock exchange to them and back as quickly as possible. Moreover, in order to shorten the distance of which the information goes through, HFT traders place their computer servers as close as possible to the stock exchange servers. This usually happens through the purchase or rental of real estate near the stock exchange. In fact, you wouldn’t believe how expensive real estate is around stock exchanges. Some stock exchanges in developed markets often offer co-location services, which enable HFT trading companies to place their servers close to the exchange’s computing server to reduce the latency.
HFT Trading – The Criticism
Since HFT traders have the ability to receive information and respond to it even before any other participants in the market, the argument says that between HFT traders and traditional traders, there is unequal competition due to Latency Arbitrage.
Between the two opposing approaches, with one side arguing that the market is rigged and the other arguing that all claims about HFT trading are a myth – many discussions are taking place nowadays, and capital market officials, such as brokerage firms and investment banks, lawyers, regulators, and academics, are debating the legitimacy of HFT trading, and whether it should be allowed or restricted.
So, what is the real problem here? The British regulator, the Financial Conduct Authority (FCA), has recently published its findings on the impact of High-Frequency trading on capital markets. The paper focuses on the impact of HFT traders and whether they can or cannot predict price movements in the markets.
One of the key findings is that HFTs are not able to systematically anticipate near-simultaneous orders sent by non-HFTs to different trading venues, but HFT traders could predict the flow over longer time periods.
Another major criticism when it comes to HFT trading is that it allows institutional financial firms to gain an advantage in trading because they are able to trade in large blocks through the use of algorithmic trading. Obviously, the financial market and trading have become a playground where the equipment is more important than trading skills.
Top HFT Companies
Globally, there are some major HFT companies that account for approximately 50–60% of the total equity trading volume. Those include:
- Citadel Securities (United States)
- Two Sigma Securities (United States)
- Flow Traders NV (Netherlands)
- Hudson River Trading (United States)
- GSA Capital Partners LLP (United Kingdom)
- IMC Trading BV (Netherlands)
- Jump Trading (United States)
- KCG Holdings Inc. (United States)
- XTX Markets (United Kingdom)
- Virtu Financial Inc (United States)
HFT (Automated) Trading – Pros and Cons
Pros:
✅ HFT trading adds liquidity to the markets
✅ Reduce costs
✅ HFT trading is part of technological advancements
Cons:
❌ Disrupt the integrity of the markets
❌ Causes irrational movements in financial markets
❌ HFT trading accounts for more than 50% of total volume on the world’s stock exchanges
❌ The HFT market is highly concentrated
❌ Change the fundamentals of trading
The Bottom Line
HFT trading is likely to stay in the financial market landscape and remain a hot debate. But the bottom line is that there are more cons than pros when evaluating the overall impact of HFT trading as part of the whole mechanism of financial markets around the world.
Perhaps it could be completely legitimate if automated (algorithmic) trading were allowed for individual investors only, but not for institutional financial firms that create an unpredictable and irrational market. If you have ever traded financial markets, you know what the discussion is all about. Back in the days when we were sitting in the trading room, we used to say: ‘They are coming’, and we always knew that they were the financial firms that had big machines and an advantage over the average Joe trader.
