High-frequency trading (HFT) is a trading approach that requires the usage of high-powered computer applications to execute a large volume of orders within milliseconds.
HFT employs pre-programmed trading commands and a multitude of complex algorithms.
These are used to analyze multiple markets simultaneously while automatically executing trades based on preprogrammed trading scenarios for varying market conditions.
Speed is of the essence with HFT, where traders with the fastest rates tend to be more profitable while the majority of high-frequency trading is performed by hedge funds, investment banks, and large institutional investors.
The use of colocation services is common amongst HFT participants given they decrease latency upwards to 20% to 50%.
These services also simplify network complexity through housing an exchange or firm’s service and equipment within their own data centers.
What Are the Risks of High Frequency Trading?
While HFT increases market liquidity by narrowing down bid-ask spreads, there are hazards that traders should be made aware.
A notable example of this was the Flash Clash in May 2020, which resulted in the markets dropping 10% within minutes.
This event was partly blamed as a result of HFT programs used by institutions.
Other risks include a potential domino effect across varying financial markets due to the close interrelationship between financial markets and traders.
There is potential for an increased market risk as a result of faulty algorithms or exacerbated trends.
Despite HFT growing in popularity, it still receives controversial backlash due to historical market events.
HFT also allows some larger financial institutions the ability to profit at the cost of retail traders.
Unless significant regulatory rollouts or mandates are changed, HFT is here to stay and will continue to play an increasing role in the future of trading.