Hackernoon logoThe Ultimate Guide to High-Frequency Trading (HFT) by@8topuz

The Ultimate Guide to High-Frequency Trading (HFT)

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@8topuzAnthony Munns

Head of Digital at 8topuz

Wouldn't it be great if you could place multiple trade orders at once? Well, thanks to high-frequency trading (HFT), you can process hundreds of orders without breaking a sweat. 

In this guide, we are going to dig deeper into HFT and HFT Software and tell you all the details you need to know about this form of trading. 

So, let's get started. 

What is HFT (high-frequency trading)?

HFT, or High-Frequency Trading, is a method that uses powerful computer programmes to process a large number of orders within a very short period of time.

To process a plethora of orders, HFT utilises an algorithm to analyse various markets and then proceed according to market conditions. 

Using HFT requires a high-speed computer. The algorithm in HFT spots individual assets based on their emerging trends and gives an instant buy order signal if all the market conditions are in favour. 

You might be wondering just how fast HFT is? HFT often sends buy or sell orders in milliseconds. This is also known as latency arbitrage. To put it simply, the faster you are, the more profitable you are. This is the reason many banks and institutional investors consider HFT as their "go-to" tool. We'll discuss in detail why financial institutions use HFT later. 

High-frequency trading in combination with large volumes is a great strategy, as it allows traders to profit from even the smallest of price movements. What HFT does is act as a market maker, generating two order placements (buy low, sell high). 

The algorithms set forth in HFT scans not only use one market but also multiple exchanges and markets. This allows traders to capture more trading opportunities. For instance, HFT with the arbitrage strategy enables you to profit from the same asset's price differences on different exchanges. HFT also works with news and trend following strategies. 

Suppose a trader wants to buy 50 GBP/USD units when the 50-day EMA (exponential moving average) goes above the 100-day EMA. He/she would use the HFT that would execute buy orders when these conditions are met. 

High-frequency traders make money on the disequilibrium of supply and demand, using arbitrage and speed as their tools. These trades are not based on how the company is performing or will perform - they are based on opportunities. 

It is worth remembering that HFT is a sub-category of algorithmic trading, and it also includes Ultra HFT. Computer-guided, rule-based, algorithmic trading uses specialised programmes that make automated trading decisions to place orders. This methodology splits large-sized orders and places these orders at different times, and even manages trade orders after their submission. This also reduces the price impact by dividing large orders into many small-sized orders, thereby offering traders a price advantage.

The algorithms also control the schedule of sending orders to the market. These algorithms read real-time high-speed data feeds, notice trading signals, recognise appropriate price levels, and then place trade orders once they identify an appropriate opportunity. 

Many supporters of HFT say that it increases liquidity in the market. Well, they are 100% right. HFT does make the market more competitive. Due to the faster execution of trades, the trading volume automatically increases. With increased liquidity, the bid/ask spread declines, and the market becomes more price-efficient. 

It's worth noting that a liquid market is less risky because there is always someone on the other side taking the opposite position. If you want to take aggressive positions in a liquid market, a stop-loss does the trick. 

When did HFT start?

2008's global recession was the biggest economic disaster of this century. Billions of dollars were lost. However, HFT survived. It was considered a "cash cow" on Wall Street as it generated $15 to $20 billion in revenue. 

So, how did HFT become that important? To answer this question, we need to understand its origins.  

Automatic trading, or computerised trading, is not new. In 1971, NASDAQ became the world's first electronic market by introducing an electronic quotation system. 

Five years later, in 1976, NYSE introduced DOT, which can buy and sell securities electronically. Later, in 1984, it introduced Super-DOT, which was faster than its predecessor. 

In his book Flash Boys, Michael Lewis explains about the origins of electronic trading in the U.S. 

In the 1980s, the popular term on Wall Street was "programme trading." This type of trading is used to place buy or sell orders for up to 15 stocks with a total worth of $15 million. In the latter half of the decade, traders could place orders for up to 500 stocks and futures contracts. It is said that the stock market crash of 1987 happened because of this programme trading

NASDAQ and NYSE dominated the 70s and 80s in computerised trading. But, the game changed with the introduction of ECN (electronic communications networks) in the late 1990s. An ECN is an automatic system that matches buy and sell orders and connects brokerages with retail traders so they can trade without going through an intermediary.  

Immediately after its launch, the ECN became popular among institutional investors, as it generated fewer trading errors. Seeing its worth, the SEC (Securities and Exchange Commission) authorised the use of algorithm trading in 1998. A year later, HFT stepped foot into financial markets. 

At that time, HFT could process orders in a few seconds. In 2010, its time reduced to milliseconds, and now it can perform in 1/100th of a microsecond. 

In 2013, Bloomberg reported that high-frequency trading now comprises 50% of all U.S. equity volume. 

Why do financial institutions use HFT?

The pacey nature of HFT makes it complex and exciting at the same time. However, retail traders constitute only a fraction of this type of trading. The real players are the large financial institutions or market makers. 

The inception of the digital world has allowed firms to use HFT to their advantage as they have the most money. According to the Deutsche Bank report, HFT is dominated by proprietary firms, which makes about 48% of the markets. Trading desks dealers make up about 46%, while hedge funds make up 6% of the total market. 

Proprietary firms like the Citi Group and J.P. Morgan, Goldman Sachs have plenty of greenbacks, and they can turn the course of the market in seconds. In May 2010, the Dow Jones faced its biggest intraday drop, declining to almost 1000 points in just 20 minutes. The SEC founded that a major selloff order triggers this deterioration. 

Knight Capital, who was considered one of the biggest players of HFT, installed software in August 2012 and accidentally sold and bought $7 billion dollars' worth of stock at unfavourable prices. The company lost 40% of its value and was eventually bought by a fellow HFT firm, Getco. 

Exchanges provide incentives for institutions to liquidate the market. Offering these small incentives exchanges profit from liquidity, and institutions that provide the liquidity also see their dollars rise. These incentives comprise a portion of a cent per transaction, which can multiply significantly in a day. This is why institutions use HFT to pick these small fruits. 

Many argue that high-frequency trading gives an unfair advantage to corporate firms and institutions, as the markets don't remain on a level playing field. This can cause a serious dent in success, especially to long-term traders. 

Imagine you are going long on EUR/USD. Your analysis suggests that in the next 30 days, the price of the pair will go up. You confidently execute your position. However, after one week, the European Central Bank has decided to lower the value of EUR to maintain a constant quantity of the currency to decrease transaction costs. 

The stock markets system suggests a level-playing field for each type of investor. But, HFT disrupts that system in a matter of seconds. Besides this, the liquidity caused by large institutions can vanish in an instant. At one moment, the market is liquid; at others, not so much. In these situations, small investors can't trade this liquidity. 

With technology becoming affordable, many companies have introduced high-frequency trading systems at a minimum of $500. These companies allow you to trade like large institutions, so you can easily compete with them.

Who should consider using HFT?

If a trader can develop an algorithm, HFT becomes accessible to all. Sitting in your pyjamas, you can trade in an instant. To develop an algorithm, you have to learn how to code. Even if you know to programme, you can't do HFT because it is regulated in some countries. You’ll need to join firms offering algorithmic trading. 

If you don't want to make use of HFT firms and would rather try it for yourself, you’ll need high-speed computers that have advanced software and hardware, and you need to update them if you want to stay in the game regularly. 

Co-location is another factor that traders need to consider for HFT. The co-location allows you to place your computer near the exchange servers, thereby reducing time delays. Also, you need to monitor real-time data feeds that can impact your profits. 

Even if you complete this checklist, you are in a crowded marketplace where everyone has their sophisticated system, not to mention large institutions. This mad race has made trading complex, even if you believe you have the best HFT system on the planet. 

Hence, major bottlenecks of HFT for an individual are declining profit potential, high operational costs, stricter regulations, and the fact that there is no room for mistakes, as losses can swiftly run in the millions.

If you don't want to lose your hard-earned money, you should probably not try and do it yourself, but instead, let HFT firms that know what they're doing generate profits for you. 

How to get into HFT investing and trading with 8topuz

It's no surprise that many retail traders want to join the flashy action of high-frequency trading. 

We at 8topuz are an AI-based software company that incorporates HFT into our trading system and solution.

Here at 8topuz, we use AI technology for trading in the forex (FX) market. Our software uses market-depth analysis and looks for pre-set mathematical patterns to forecast market trends in real-time.

Our system finds short-term volatility breakouts by backtesting them and allowing trades with proper risk management. Trades are generally executed within milliseconds.

Our solution has been designed to offer long-term growth so you can earn consistent profits.

Our products come with investment tracking, so that you can assess your investment portfolio. Plus, there is no account fee or management fee.

Bottom line

HFT's has attracted many investors since its creation in the 1970s. Although large corporations have an advantage in HFT, retail traders can compete with them by using AI-based investing software.


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