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High Frequency Trading Strategy – What Is It and How to Get Started

  • 18 mins read ●
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high frequency trading strategy

Within the trading industry, no concept sparks as much controversy as the High-Frequency trading strategy. As studies seem to clash, leaving traders with more questions than answers, we find ourselves here, ready to dive into the heart of it.

KEY POINTS
  • High-frequency trading (HFT) is a rapidly evolving strategy in finance, employing computer programs and AI to execute trades in fractions of a second.
  • HFT has both proponents and critics, with claims that it enhances liquidity and reduces trading costs, but also concerns about market stability and fairness.
  • Retail traders face challenges entering HFT due to the need for unmatched speed, substantial capital, costly technology, and complex regulations.
  • Expert Advisors (EAs) offer retail traders a way to engage in trading that resembles HFT by using automated algorithms.
  • Various HFT strategies include market making, quote stuffing, ticker tape trading, statistical arbitrage, and more, aiming to capitalize on market inefficiencies.

In this article, we explore the world of HFT, from its origins and key strategies to the challenges faced by retail traders and the tools needed to participate. We’ll examine the pros and cons of HFT, its ethical implications, and the critical question of its profitability.

What is High Frequency Trading (HFT)?

High-frequency trading, often abbreviated as HFT, is a fascinating and rapidly evolving segment of the financial world. It has come a long way since its inception in the early ’80s, with NASDAQ pioneering electronic trading. 

Back in the early 2000s, high-frequency trading represented less than 10% of equity orders. However, this proportion started to grow rapidly, with trading volume increasing by about 164% between 2005 and 2009. By 2009, it accounted for a staggering 73% of all equity orders in the United States. Major players in this field included Virtu Financial, Tower Research Capital, IMC, Tradebot, Akuna Capital, and Citadel LLC.

So, how does high-frequency trading work? Technically, high-frequency trading employs a combination of computer programs and artificial intelligence networks to automate trading processes. This strategy relies on algorithms to scan various markets and identify investment opportunities. The key to its success lies in automation, enabling large trading orders to be executed in just fractions of a second.

The Securities and Exchange Commission (SEC) has outlined five common characteristics of high-frequency trading:

  • Utilization of incredibly fast and advanced programs for generating, routing, and executing orders.
  • Use of co-location services and individual data feeds to minimize network and other latencies.
  • Very short time-frames for establishing and liquidating positions.
  • Submission of numerous orders, often canceled shortly after submission.
  • Aim to end the trading day as close to a flat position as possible, avoiding significant unhedged positions overnight.

In a nutshell, the HFT trading method is done by using powerful computers to execute many orders in fractions of a second. T For example, let’s say a company is listed on the US and UK stock exchanges. The stock’s price obviously cannot be the same at any given moment. This is known as arbitrage – HFT traders, equipped with powerful computers and lightning-fast execution, buy the stock on one exchange and sell it on the other. They can do hundreds and even thousands of transactions in a day. It’s basically a money-making machine.

Yet, while HFT works in favor of those who have, there’s a lot of criticism from those who don’t. Over the past years, high-frequency trading has been a subject of debate and research. Some claim it improves market liquidity, narrows bid-offer spreads, and makes trading more cost-effective for market participants. Academic studies have shown that it can lower the cost of trading, particularly for large-cap stocks in generally rising markets.

On the other hand, there’s an opposing view. Critics argue that HFT can exacerbate price fluctuations, particularly in turbulent or declining markets. The efficiency of HFT has been questioned, as it generates a significant amount of quote traffic relative to the value of trade transactions.

Either way, high-frequency trading has significantly influenced the structure of financial markets. It has led to increased competition among exchanges to provide faster processing times, measured in milliseconds or microseconds. The need for speed has pushed technology advancements, with exchanges like the London Stock Exchange boasting remarkably low latencies.

One of the most notable events associated with high-frequency trading is the May 6, 2010, Flash Crash. Initially thought to be caused by HFT, it caused a dramatic drop in the Dow Jones Industrial Average. The debate about its role in this event continued, with some arguing that HFT may have helped stabilize the market, while others believed it contributed to the crash’s severity.

All in all, high-frequency has transformed the landscape of financial markets, especially in the futures and the stock market, bringing speed and automation to the forefront. However, its impact on market stability, efficiency, and volatility continues to be a topic of interest and concern.

Can a Retail Trader Do High-Frequency Trading?

High-frequency trading has long been the domain of well-funded institutions such as investment banks and hedge funds armed with cutting-edge technology. But what about retail traders? Can they venture into this high-speed, high-stakes world of trading? The answers to these questions are not as straightforward as one might hope, and here’s why:

On one side of the coin, it’s important to acknowledge the challenges faced by retail traders who aspire to engage in HFT trading. High-frequency trading demands a level of infrastructure and resources that often surpass the means of individual traders. Here are some significant hurdles they encounter:

  • Unmatched Speed: HFT thrives on speed; orders must be executed in fractions of a second to capitalize on fleeting market opportunities. Achieving this level of speed necessitates powerful hardware and direct connections to the market, a feat beyond the typical resources of most retail traders.
  • Capital Intensity: High-frequency trading often requires leveraging substantial capital to profit from minuscule price movements. Retail traders may find it challenging to compete in this high-stakes financial league where significant capital is the key to success.
  • Technology Costs: Establishing the necessary technology infrastructure, including high-performance computers and VPS services, can be costly. These expenses can quickly become prohibitive for individual retail traders, limiting their access to the world of HFT.
  • Regulatory Complexity: HFT operates within a regulatory landscape designed to ensure market fairness and integrity. Complying with these complex regulations can be daunting for individuals, discouraging retail traders from diving into HFT.

So, the short answer is no. HFT, in its purest form, is almost impossible for retail traders.

However, there is another side to this story. While direct HFT may be out of reach for most retail traders, there is still a pathway for them to participate in trading that resembles HFT through the use of Expert Advisors.

Expert Advisors are automated trading programs that can execute predefined trading strategies without human intervention. While not HFT in the strictest sense, EAs can swiftly respond to market conditions, opening and closing positions within seconds.

Whether done manually or automatically, EAs enable retail traders to employ algorithmic strategies that mimic some aspects of HFT. These strategies can identify trading opportunities and execute orders with minimal delay.

So, in short, while pure high-frequency trading remains a realm primarily reserved for institutional players, retail traders have a foothold in the world of high-speed trading through Expert Advisors. Still, it’s essential to approach this cautiously, understanding that even with EAs, challenges and risks persist.

HFT employs a combination of computer programs and artificial intelligence networks to automate trading processes. This strategy relies on algorithms to scan various markets and identify investment opportunities.

High-Frequency Trading Strategies – Different Types and Methods

Now that we’ve explored the fundamentals of High-Frequency trading let’s have a deeper look at its diverse array of strategies.

1. Market Making

Market-making is a strategy that plays a central role in high-frequency trading. It’s not uncommon for High-Frequency trading firms to identify themselves as market makers. This approach involves placing limit orders to buy or sell, aiming to earn profits from the bid-ask spread. Market makers serve as counterparts to incoming market orders, improving liquidity. While this role was once exclusive to specialist firms, it’s now embraced by a wide range of investors, thanks to direct market access.

It’s crucial to note that true market makers don’t have the discretion to exit the market at will. They commit to staying in the market, which differentiates them from HFT firms, offering more flexibility.

Some prominent players in this space, like Automated Trading Desk (ATD), account for a substantial percentage of trading volume on major exchanges. Citadel LLC, for instance, acquired ATD’s assets in May 2016. Creating market-making strategies involves intricate modeling of the market microstructure coupled with stochastic control techniques.

2. Quote Stuffing

Quote stuffing is a controversial practice often employed by high-frequency traders. This strategy involves rapidly entering and withdrawing a large number of orders with the aim of flooding the market. The intention here is to create confusion and trading opportunities for HFT firms. Such practices can lead to disciplinary action as they can disrupt the normal flow of the market.

3. Ticker Tape Trading

Market data, including quotes and volumes, holds a wealth of information. High-frequency trading algorithms are adept at extracting information that has yet to reach the news screens. Since all quote and volume data is public, these strategies adhere to legal boundaries. 

Ticker tape trading, also known as Level 2 market data, a component of this approach, involves monitoring stocks for significant price changes or volume activity. This can include trading on announcements, news, or specific event criteria, with software generating buy or sell orders accordingly.

4. Tick Trading

Tick trading focuses on identifying the beginnings of large orders entering the market. For example, when a pension fund begins a substantial buying order, it may take place over hours or days, causing a rise in the asset’s price due to increased demand. An arbitrageur tries to detect this and profit from selling back to the pension fund. However, this strategy has become more challenging with the introduction of dedicated trade execution companies.

5. Statistical Arbitrage

High-frequency traders often employ statistical arbitrage strategies. These strategies capitalize on predictable, temporary deviations from stable statistical relationships between securities. This approach is applied to liquid securities, spanning equities, bonds, futures, and foreign exchange. Some of these strategies involve classical arbitrage techniques, such as covered interest rate parity in the foreign exchange market.

6. Index Arbitrage

Index arbitrage strategies revolve around index tracker funds that buy and sell securities based on their changing weights in indices. HFT firms that can access and process information predicting these changes ahead of tracker funds can buy and sell securities at a profit.

7. News-Based Trading

Company news, often available in electronic text format from various sources, provides opportunities for news-based trading. Automated systems can swiftly identify company names, keywords, and semantic cues to make trades based on news before human traders can react.

8. Low-Latency Strategies

A particular class of HFT strategies relies on ultra-low latency direct market access. These strategies prioritize speed to gain tiny advantages in simultaneously arbitraging price discrepancies across different markets.

Intriguingly, the shift from fiber optic to microwave and shortwave technology for long-distance networking has been a significant development. Microwave transmission offers a speed advantage due to less signal degradation than light traveling through fiber optics.

High-Frequency trading, in its purest form, is almost impossible for retail traders. However, there is another side to this story. While direct HFT may be out of reach for most retail traders, there is still a pathway for them to participate in trading that resembles HFT through the use of Expert Advisors.

Tools and Services Needed for HFT

To start High-Frequency trading, you’ll need more than just a desire for success; you’ll need the right tools and services to navigate the fast-paced financial markets effectively. With that in mind, here are some of the essential tools and services needed for HFT:

Powerful Computer

Your high-frequency trading setup begins with the heart of your operation: a powerful computer. When milliseconds matter, your computer’s processing speed, memory, and overall performance can make all the difference. It’s your trading command center, where you’ll execute strategies, analyze data, and monitor market movements in real-time. It might be expensive, but if you want to start HFT, you must look for the best trading computer to buy.

VPS Service

A crucial piece of the HFT puzzle or algorithmic trading is a Virtual Private Server (VPS) service. Why is it so important, you ask? The answer lies in avoiding slippages and disconnections, both of which can be detrimental in high-frequency trading. A reliable VPS ensures that your trading platform runs smoothly and without interruptions.

One notable VPS provider that caters specifically to high-frequency traders is ForexVPS. Their service is designed to meet the unique demands of HFT. It offers low-latency connections and high-speed data transfer, helping you execute trades with precision and without the worries of downtime.

Lightning Fast Execution

When you’re in the world of HFT, speed is your most potent ally. Lightning-fast execution means you can capitalize on market opportunities before they slip away. This rapid execution enables you to make split-second decisions and seize those fleeting moments when they matter most.

Zero Spreads and Low Trading Commissions

In HFT, every fraction of a cent counts. That’s why minimizing costs is crucial to success. Look for trading platforms and brokers that offer zero spreads and low trading commissions. These factors directly impact your profit margins, allowing you to optimize your gains.

Armed with these essential tools and services, you’re well-prepared to venture into the world of high-frequency trading. These elements lay the foundation for your HFT success, helping you confidently navigate the complexities of fast-moving financial markets.

High-Frequency Trading Strategy – Ways to Get Started

So, you’ve decided to venture into the world of high-frequency trading. But where do you begin? Let’s explore the key steps to start with the HFT strategy.

Start a Hedge Fund or Investment Company

Launching your own hedge fund or investment company is the most common pathway for entering the world of HFT. This approach provides you with the autonomy to develop and implement your high-frequency trading strategies. Here’s what you need to consider:

  1. 1Capital: High-frequency trading requires significant capital. You’ll need to raise funds from investors or allocate your resources to build a trading infrastructure, execute trades, and manage risk effectively.
  2. Legal and Regulatory Compliance: Establishing a hedge fund or investment company requires regulatory obligations. You’ll need to navigate the legal landscape, which may vary by jurisdiction, and ensure compliance with financial regulations.
  3. Technology and Infrastructure: Setting up a robust technology infrastructure is paramount. This includes high-performance computers, low-latency connections, and advanced software for algorithmic trading.
  4. Risk Management: Developing effective risk management protocols is crucial. HFT involves rapid trading and exposure to market volatility. Robust risk controls are essential to protect your capital.

Learn Programming Languages

A solid foundation in programming is essential for anyone aiming to engage in high-frequency trading. You need to understand and work with programming languages that are commonly used in algorithmic trading, such as:

  1. Python: Python is a versatile and widely used programming language in the finance industry. It’s known for its simplicity and extensive libraries, making it an excellent choice for developing trading algorithms.
  2. C++: C++ is known for its speed and efficiency, making it a favored language for high-frequency trading systems. Mastery of C++ allows you to optimize algorithms for rapid execution.
  3. Java: Java is another popular choice, offering portability and a robust ecosystem for developing trading applications.
  4. MATLAB: MATLAB is often used to research and prototype trading strategies. It provides a wide range of financial modeling and analysis tools.
  5. R: R is valuable for statistical analysis and modeling in algorithmic trading. It’s particularly useful for developing statistical arbitrage strategies.

Once you learn the programming language of your trading platform, you can automate your trading based on your trading strategy. Remember, you can automate your trading manually or use a built-in automated plugin on your trading platform. Either way, knowing programming languages is a key step in mastering HFT.

Note that you can also automate your trading using AI bots, such as ChatGPT. For more information, you can read our guide about ChatGPT trading strategies.

Purchase Expert Advisors

For those looking to start indirectly with HFT without establishing a hedge fund or learning programming languages, you can consider purchasing Expert Advisors. EAs are pre-built trading algorithms designed for specific trading platforms, like MetaTrader 4 and 5. They provide a shortcut to implementing HFT strategies and can be a cost-effective way to begin. However, these EAs can cost a fortune to acquire. Also, you need to learn how to download and install customer indicators to MT4 and MT5.

High-Frequency Trading – Pros and Cons

High-frequency trading is a trading strategy that has polarized the financial world. But while its profitability is unquestionable for large financial institutions, it has some advantages and disadvantages for the average Joe trader.  Let’s dive into the pros and cons of this controversial practice.

Pros

  • High Chances of Profitability: HFT can encompass high chances of profitability. If a strategy is tested and proven accurate, it is a money-making machine. Morewoevr, HFT traders are neutral and have no side in the market. In any market caondition, HFT traders are expected to make profits.
  • Speed and Efficiency: HFT excels in executing orders with incredible speed, capitalizing on microsecond opportunities that may otherwise go unnoticed. For retail traders, this means swift trade execution, reducing exposure to market fluctuations and potentially resulting in better trading results.
  • Automated Precision: HFT relies on algorithmic precision to execute trades. This means that trading decisions are not influenced by human emotions or fatigue. Retail traders can implement automated trading strategies that execute trades consistently, following predefined rules, which can lead to more disciplined trading.
  • Lower Trading Costs: The liquidity provided by HFT can result in tighter spreads and reduced commissions. These cost-saving benefits can be passed on to retail traders, making trading more affordable in the long run.

Cons

  • Capital Requirements: HFT typically demands substantial capital to compete effectively. Retail traders may find it challenging to amass the financial resources required to engage in HFT fully. Without adequate capital, they may struggle to compete with larger players.
  • Complex Technology: Establishing the necessary technology infrastructure for HFT can be complex and expensive. This includes acquiring high-performance computers, securing low-latency connectivity to the markets, and maintaining a stable and redundant trading setup. The cost and complexity of this technology can be a significant barrier for retail traders.
  • Regulatory Challenges: HFT operates within a complex regulatory environment, with rules designed to ensure market fairness and integrity. Complying with these regulations can be time-consuming and daunting. Retail traders must invest effort in understanding and following these rules, or risk regulatory actions that can harm their trading activities.
  • Ethical Concerns: HFT has faced ethical scrutiny, with concerns that it gives an unfair advantage to large firms and disrupts market balance. Some market participants argue that HFT can manipulate markets and impact prices unfairly. Retail traders should consider these ethical concerns and their implications when engaging in HFT.

The State of HFT In The Trading Industry

According to Grand View Research, the global HFT market is on an upward trajectory. They project a compound annual growth rate of 3.5% from 2021 to 2028. In 2020, the overall size of the HFT market was estimated to be a substantial $387 million. And this number is expected to continue growing over the next decade.

However, though the HFT market size is growing, its purpose is not yet clear. High-frequency trading has its fair share of skeptics and defenders. The CEO of Robinhood, a prominent trading platform, has defended HFT practices by arguing that they yield better prices for traders. This viewpoint suggests that HFT can be a profitable approach for those who embrace it.

On the flip side, there’s a growing number of traders taking legal action by filing lawsuits against exchanges that employ high-frequency trading. These lawsuits underscore the contentious nature of this strategy.

The ethical impact of high-frequency trading is a topic of debate among professionals. Critics argue that HFT gives large firms an unfair advantage and disrupts the market’s equilibrium. They claim that when HFT results in adverse market impacts and benefits only a select few, it becomes unethical.

One of the ethical concerns surrounding HFT is its ability to influence the market through non-bona fide trades. Such actions can cause significant shifts in demand and supply, ultimately impacting security prices. This strategy also places smaller investors at risk and is not conducive to long-term investing.

Surely, high-frequency trading is a double-edged sword. It brings profits to those who can master its intricacies, but it also raises ethical concerns and challenges the balance of the market. 

The ethical impact of high-frequency trading is a topic of debate among professionals. Critics argue that HFT gives large firms an unfair advantage and disrupts the market’s equilibrium. They claim that when HFT results in adverse market impacts and benefits only a select few, it becomes unethical.

Final Word

Unarguably, high-frequency Trading (HFT) offers a complex landscape for retail traders. It presents an enticing prospect of swift profits and rapid transactions but is fraught with challenges that can seem insurmountable.

For most individual traders, direct engagement in HFT remains a distant goal. Some might say it is an impossible one. It demands substantial capital, cutting-edge technology, and a profound grasp of intricate regulations, prerequisites typically met by large institutions and industry titans.

However, there is a glimmer of hope. Retail traders need not remain bystanders in the realm of high-speed trading. Expert Advisors (EAs) provide an avenue to emulate certain HFT characteristics. EAs can swiftly react to market changes, executing trades in mere seconds, thus granting a taste of high-frequency-like trading to a broader audience.

In essence, HFT, through EAs, extends opportunities to retail traders. It underscores the need for a thorough understanding of the risks and potential rewards. Whether as spectators or active participants, the world of high-frequency trading profoundly influences how retail traders navigate financial markets, leaving an enduring impact.

Frequently Asked Questions About the HFT Trading Strategy

Here are some popular questions on High-Frequency Trading Strategy:

Can normal people do high-frequency trading?

High-frequency trading (HFT) is primarily the domain of professional traders and financial institutions. The speed, technology, and capital required make it challenging for the average person to engage in direct HFT. However, some individuals use automated trading strategies or trading robots known as Expert Advisors (EAs) to participate in high-frequency trading indirectly.

How much does it cost to start a HFT?

The cost of entering the world of high-frequency trading varies significantly depending on your strategy and objectives. If you have your algorithm, you don’t require external capital, and aren’t pursuing the fastest execution or executing a vast number of trades on multiple exchanges, it’s possible to get started for around $20,000 in the first year. This amount covers out-of-pocket expenses to third parties and excludes any salary costs. However, if your goal is to compete with the largest HFT firms, engaging in various HFT strategies, a more realistic estimate might be around $20 million.

How to start HFT retail trading online?

While retail traders can technically engage in high-frequency trading (HFT) after obtaining permission from regulatory bodies like SEBI, it’s important to note that HFT typically demands a substantial amount of capital. This is why many retail investors tend to avoid venturing into HFT, as the financial requirements can be challenging to sustain over the long term. However, many retail traders claim they can participate in HFT by using EAs, or by learning programming languages and developing an automated trading software.

How do I prepare for high-frequency trading?

Preparation for HFT involves education, technology investment, algorithm development, risk management, thorough testing, simulated practice, capital allocation, and staying updated on market conditions.

Can I trade HFT on cryptocurrency markets?

Yes, it’s possible to engage in HFT on cryptocurrency markets, as they share many characteristics with traditional financial markets. As a matter of fact, since large finanical instittuins and banks do not directly particiapte in the crypto market, it is the most lucrative market for high-freuqency trading activities. Yet, you’ll need the right technology infrastructure and trading platforms that support cryptocurrency trading.

What is the impact of latency in HFT?

Latency, or the delay in data transmission, can be detrimental in HFT. Even a small delay can result in missed opportunities or losses. HFT firms use low-latency technology and co-location services to minimize network delays.

Is HFT accessible to traders outside major financial hubs like Wall Street?

Yes, HFT is not limited to major financial hubs. With the right technology and infrastructure, traders from around the world can engage in HFT. However, proximity to major exchanges and data centers can offer advantages in reducing latency and execution speed.


Risk Disclosure: The information provided in this article is not intended to give financial advice, recommend investments, guarantee profits, or shield you from losses. Our content is only for informational purposes and to help you understand the risks and complexity of these markets by providing objective analysis. Before trading, carefully consider your experience, financial goals, and risk tolerance. Trading involves significant potential for financial loss and isn't suitable for everyone.

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