What is High Frequency Trading?

Intermediate
April 24, 2023
Read time:
6m

High-Frequency Trading (HFT) relies on advanced trading algorithms and high processing speed to make instant trades.


Traders get information from many sources, such as exchanges, news portals, and social media, including data about prices, trading volumes, market trends, and more. The data is then analyzed to help HFT traders make quick trading decisions.


How does the HFT work?

High-frequency trading relies on advanced technologies with high computing power and specialized software to process vast amounts of data in real-time and perform trades based on asset prices. The HFT is capable of processing several hundred trades per day and is often used in cryptocurrency trading to profit from sudden price fluctuations.


HFT can be paired with different trading strategies, such as arbitrage trading (where traders take advantage of price differences between exchanges), and trend and market pattern analysis to predict price movements.


HFT algorithms and technologies

HFT employs various algorithms and technologies to enable rapid data processing and real-time trading decisions, including:

  1. Trading algorithms - software programs that automatically execute trades based on specific criteria, including arbitrage strategies, trading based on patterns, and technical indicators.

  2. RAM databases, allowing fast access to data and speeding up the execution of operations.

  3. FPGA coprocessors - special electronic circuits that enable high-speed data processing and are often used to speed up commercial algorithms.

  4. Cloud-based software solutions, commonly utilized to process vast amounts of data and perform real-time computing.

  5. Servers, usually placed close to the exchanges to minimize processing delays and reduce the time it takes to complete transactions. Co-locating these devices on an exchange’s premises can be costly but can provide even faster transaction processing.

How to start trading with HFT?

HFT requires knowledge of mathematics, statistics, computer science, and an understanding of financial markets. In order to begin, you should acquire theoretical knowledge and explore the mathematical and algorithmic theories on which HFT is based.


Next, work for a company that already uses HFT or work alone to gain practical experience, which requires a great deal of discipline and commitment.


Then, you should choose the right trading platform that suits your needs and allows for the quick processing of large amounts of data in real-time. Be sure to have the appropriate tools, such as trading automation software, high-speed internet connections, and low-latency servers. It is essential to invest in quality tools that will ensure speed and reliability in performance.


Finally, test your skills first. Trying your strategies on historical data or under simulation conditions is a good idea. This will help you verify the effectiveness of your strategy and assess your investment risks.


HFT and Market Making

High-Frequency Trading (HFT) companies act as market makers by constantly placing orders to buy or sell an asset, earning the bid-ask spread, and ensuring that investors can trade at any time.


HFT automates market making. The algorithms track the current prices of an asset and respond to them immediately by opening offers. Using this algorithm, traders are able to make decisions in real-time, allowing them to profit from small price movements in the market.


Advantages of HFT

  1. Efficiency: HFT is more cost-effective than traditional investment strategies, as it reduces trading costs by automating the process and minimizing human influence on investment decisions.

  2. Increased market liquidity: HFT provides a steady stream of buy and sell orders.

  3. Velocity: HFT allows high-speed information processing and real-time decision-making using advanced technologies.


Disadvantages of HFT

  1. High risk: HFT requires high decision speed and accuracy. If trading algorithms do not work correctly, the risk of mistakes and potential losses is higher.

  2. Investor inequity: HFT allows the use of data before other market participants and makes investment decisions before they appear on the market.

  3. Ethical controversy: HFT may lead to the use of knowledge and information unknown to the broader public and, thus, to a kind of market manipulation.

  4. Potential price increase: HFT traders execute many trades in a short period of time, which can lead to sudden, unexpected changes in the price of an asset.


Summary

HFT is a trading strategy that uses advanced algorithms and technology to make fast transactions in the financial market, including crypto. It has advantages, such as speed of information processing, cost efficiency, and increased market liquidity, but also disadvantages, such as high risk, inequality to other investors, and ethical controversy.

Before deciding to use HFT, it is necessary to thoroughly understand the principles and risks associated with this strategy.

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