What is high frequency trading?

Answer:

High frequency trading (hft) is the automated trading Platform used by large investment banks, hedge funds and institutional investors which utilizes powerful computers to do a large number of orders at very high speeds. These high frequency trading platforms allow traders to execute millions of orders and scan multiple markets and exchanges in a few seconds, thus giving the institutions that use the platforms a huge advantage in the open market.

The systems use complex algorithms to analyze markets and able to identify new trends in fraction of second. Being able to recognize shifts in the market, the trading systems send hundreds of baskets of shares on the market on BID-ask spreads that are advantageous for traders. In fact, anticipating and beating the trends in the market, institutions that implement high frequency trading can receive profitable returns on trades that they do in fact their spread on the bid and offer, resulting in a significant profit.

Securities and exchange Commission (sec) has a formal definition of hft, but it is attributed with certain features listed below:

  • The use of extraordinarily high speed and sophisticated programs for generating, routing and execution of orders.
  • The use of services and individual data feeds offered by exchanges and others to minimize network and other latencies.
  • A very short time to create and eliminate positions.
  • There are numerous orders that are cancelled shortly after submission.
  • The end of the trading day in as close to flat position as possible (that is, not carrying significant, unhedged positions overnight).
  • High frequency trading has become commonplace in the markets after the introduction of the incentives provided by stock exchanges for institutions to add liquidity to the markets. Offering small incentives to these market makers, enhancing exchanges increases liquidity, and institutions that provide liquidity and net profit in every transaction they make, on top of their favorable spreads. Although the spreads and incentives amount to a fraction of a cent per transaction, multiply that large number of trades per day is a significant profit high frequency traders.

    Many see high frequency trading as unethical and an unfair advantage for large companies in relation to smaller institutions and investors. Stock markets should be fair and equal rules of the game, to which hft may break, because this technology can be used to abuse ultra-short-term strategies. High frequency traders are cashing in on any imbalances between supply and demand, using the arbitration and speed to their advantage. Their traders are not based on fundamental research about the company and its growth prospects, but the opportunity to strike. Although hft is not a goal anyone in particular, it can lead to collateral damage for retail investors and institutional investors such as investment funds that buy and sell in bulk.

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