What is High Frequency Trading?


What is high frequency trading? This is one of the most advanced ways of trading the market, in this case, the high frequency trading is based on advanced trading platforms that are very powerful, and they process the financial information provided or any given market condition at a particular time to transact millions of trades.

 

What is High Frequency Trading?

 

These high frequency trading strategies are applied based on algorithms developed by very skilled mathematicians, engineers, physicists, and skilled programmers.

These teams of individuals study various market conditions that they can capitalize on, and they create algorithms that will exploit that particular situation in the market many times over all through a trading day on any particular market.

There are some recurring characteristics of high frequency trading, and these are some of those characteristics that are similar across the board.

They are; hi frequency trading is characterized by high-speed trades up to a million trades within a second or less. High frequency trading has a high turnover rate compared to any other time of trading out there.

 

How High Frequency Trading Works?

 

High frequency trading has a high order to trade ratio; this means that there is a high number of orders based on the number of trades made; a particular trade can have over a million orders attached to it.

Hi frequency trading uses the access to high frequency market data to arrive at trades and this, in turn, is used to create as many trading opportunities as possible based on the data that is being received at every given moment.

High frequency trading utilizes advanced trading tools and computers to execute and run the algorithms at peak performance.

High frequency trading is only done on ultra short term time periods, the trades made do not last any longer than half a second or even less, in order to be able to have trades like that one should have the best trading platforms to handle that type of trading.

With the high number of orders executed so is the number of orders canceled, the algorithms are able to decipher good trading opportunities from those poor opportunities in a fraction of a second and act accordingly.

One might think that this type of trading may lead to the use of a serious amount of capital, but they could not be any wrong.

This type of trading does not utilize as much capital as the normal buy and hold; the margin requirements are incomparable, and this makes it a very lucrative style of investments for many institutions.

The other notable characteristic is that high frequency trading is not about accumulating positions, they are only interested on the fractional changes in price, and they maximize on this opportunity by opening as many positions as possible to get as much as possible from this changes.

This can be called by another ultra scalping. Compared to the long-term investors and traders who buy and hold, the high frequency trading participants have a ten times better risk-reward potential.

 

The Role of High Frequency Trading

 

The high frequency trading has also been part of a controversy that almost led to the collapse of the market.

In May 6th, 2010 the caused a Flash Crash that lasted a few seconds, and the market reversed back to normalcy, the fact that high frequency trading provides most of the liquidity in the markets; there is a high possibility for causing a collapse if they stop playing this role.

Their role as a liquidity provider cannot be ignored after instances like the one mentioned above. It is easier to trade now as a retail trader even as an institutional trader because of the high frequency trading activities. The more liquidity they provide, the easier it is for traders to have access to very low bid and offer spreads.

When they step out, they leave a huge gap that the traders both from the institutional and retail side have to cover on the basis of spreads and massive commissions.

High frequency trading has also been very significant in opening up the financial market to a wider range of clients who would want to participate in it.

They have made it possible for retail clients and retail brokerage firms to come in and boost the liquidity in various markets, especially the foreign exchange and equities market.

They have enabled advancements of trading technology in the sense that many trading institutions have had to adapt to the advancements in order to keep up with the liquidity providers which is important in an industry like this one.

 

High Frequency Trading Market Share

 

High-frequency trading has been around for quite a while now but after the Securities Exchange Commission allowed electronic trading back in 1998, that is when the high frequency trading came to life, and their input in the market was felt far and wide.

In 2000 the high frequency trading took up 10% of the trade volume in the equities market that was a fair share but nothing like 60-73% before the mortgage crisis in the United States.

This number has dropped to 50% which is quite a massive portion but the better since they have a massive role to play as liquidity providers in the market.

To add to this they are recognized by the New York Stock Exchange as Supplementary Liquidity Providers or SLPs; their role is to inject as much liquidity as possible into the market and because of their efforts they are awarded rebates by the exchange.

This boosts liquidity and thus improves the quality of the spreads quoted in the market. The rebates as of 2009 were $0.0015 per trade, and this meant that they make a lot of money considering they make millions of trades a second or less.

These incentives came after the collapse of Lehman Brothers following the mortgage crisis that almost crippled the markets. The presence of high frequency trading allows for a sound trading environment.