High-frequency trading (HFT)

DEFINITION of High-frequency trading (HFT)

High-frequency trading (HFT) is the use of sophisticated algorithms and high-end hardware optimally located to gain an advantage in stock market trading.

WHAT IT IS IN ESSENCE

High-frequency trading (HFT) is a type of algorithmic trading with characteristics of high speeds, high turnover rates.

Also, the high order-to-trade ratios that leverage high-frequency financial data and electronic trading tools.

There is no single definition of HFT. Among its key attributes are highly sophisticated algorithms, co-location. Above all, with very short-term investment horizons.

HFT can be a primary form of algorithmic trading in finance. Specifically, it is the use of sophisticated technological tools and computer algorithms to rapidly trade securities.

It uses proprietary trading strategies carried out by computers to move in and out of positions in seconds or fractions of a second.

It can be used to either find the best price for a single large order. Or to find opportunities for profit in the market in real time.

In 2017, Aldridge and Krawciw estimated that in 2016 HFT on average initiated 10–40% of trading volume in equities. And 10–15% of volume in foreign exchange and commodities.

Intraday, however, the proportion of HFT may vary from 0% to 100% of short-term trading volume.

Previous estimates reporting that HFT accounted for 60–73% of all US equity trading volume. With that number falling to approximately 50% in 2012 were highly inaccurate speculative guesses.

High-frequency traders move in and out of short-term positions at high volumes and high speeds. Aiming to capture sometimes a fraction of a cent in profit on every trade.

HFT firms do not consume significant amounts of capital, accumulate positions. Or, hold their portfolios overnight, for instance.

As a result, HFT has a potential Sharpe ratio (a measure of reward to risk) tens of times higher than traditional buy-and-hold strategies.

HOW TO USE

High-frequency traders typically compete against other HFTs, rather than long-term investors. Such firms make up the low margins with incredibly high volumes of trades. 

The algorithms are extremely complex, allow the program to trade across several markets at once.

The advantage of HFT is in quickly processing trades. So the focus is on the power of computers used and location of computing programs. 

By placing themselves nearby to the exchanges taking orders, HFT firms can gain millisecond advantages over their rivals. In some trading, it can be of vital importance.