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AI in Finance – HFT case study

If you are learning the basics of algorithmic trading, then you probably already came across the term high-frequency trading or HFT. According to experts, HFT companies account for 50-60% of the trading volume in the US stock market, and the names of these firms are associated with success and high profits. So what is HFT trading? How do traders manage to achieve such speed and trading volumes? What can we learn from our HFT colleagues to avoid falling victim to them? In this article, we’ll cover everything you need to know about HFT trading.

What is high-frequency trading?

HFT is a type of algorithmic trading that is characterized by high speed, high capital turnover, and short asset holding times. For high-frequency trading, robots and powerful computers are used, which conclude dozens of transactions in literally milliseconds. They usually trade small volumes to test the market and often work in so-called dark pools. Therefore, you will never know that a high-frequency trader is against you. Last but not least, HFT traders often stand behind so-called flash crashes – sudden market crashes followed by a rebound.

High-frequency trading on the exchange

High-frequency trading accounts for more than 70% of all orders on the US stock exchanges, 40% in the European, and 10% in the Asian. To provide the speed required for HFT, the exchange must have colocation servers, that is, the trader’s server must be located in the same data center or cloud as the exchange server.

Traders are increasingly relying on electronics and automation, and this is happening in all markets. Market makers and arbitrage traders trade more efficiently, and this affects pricing, price discovery, and liquidity. Arbitration windows are getting smaller and closing faster, indicating a more efficient and mature market.

It should be said that HFT is gradually gaining a foothold in the Forex trading as well. Most notably in Africa where this field is on surge customers of best brokers in South Africa try to implement this strategy. However, it has faced a lot of opposition from some traders.

HFT in crypto

Today, many HFT companies and traders are gradually moving to the cryptocurrency market, because, firstly, it is much more volatile than traditional markets, which makes it possible to earn money, and secondly, cryptocurrency exchanges need HFT companies as liquidity providers. The fact is that in traditional markets liquidity is supported by market makers, and at the moment when it becomes unprofitable to close liquidity holes at their own expense, they attract HFT companies or use high-frequency trading themselves. Simply put, the cryptocurrency market is a new opportunity for earning money for traders and companies using high-frequency algorithmic trading.

Advantages and Disadvantages of HFT Trading

In traditional markets, HFT algorithmic trading has been around for decades – and HFT has always been controversial.

Advantages 

  • Increases liquidity
  • Increases trading volume
  • Reduces bid-ask spread
  • Improves the efficiency of pricing

Disadvantages

  • Increases volatility
  • HFT traders make money from small players
  • Sometimes HFT is associated with prohibited manipulations, including spoofing and layering

Spoofing and so-called layering are automated market manipulation mechanisms that allow you to overtake other market participants. Spoofers create the illusion of a high supply or demand of an asset by placing multiple limit orders on one side of the order book, so it appears that there is pressure to buy or sell in the market. The layering technique is that a trader first creates and then cancels a large number of orders in order to make the price rise or fall.

High-frequency trading software

There are two main ways to join the ranks of HFT traders. The first is to find a specialized broker. The second is to buy powerful hardware and install special software. There are several developers on the market, but before you pay serious money for a program, you need to plan your next steps.

  • You will need to decide on strategies. The software developer will sell you only the program itself – no strategy, algorithm, or signals.
  • HFT trading is associated with high costs: this includes costs for colocation, broadband internet, broker fees, etc.
  • High-frequency trading programs require careful setup before trading.

High-frequency trading is gaining popularity in the market

HFT is an extremely efficient way to trade, which is why it is so popular in the financial markets. Institutional investors spend billions of dollars annually to develop and implement high-frequency strategies. HFT is conquering new markets – including the crypto market – and has increased media coverage. Ordinary traders can only accept the presence of HFT and avoid the traps of high-frequency traders whenever possible.

But once again some deem this strategy as unfair and throughout the recent decade, HFT has faced a backlash from traders. It is difficult not to agree with them because as we have seen above, HFT has some serious disadvantages as well. 

Sony T
Sony is a passionate bloggers writes on Futuristic technologies ...

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