By Nathan Boardman
High-frequency trading (HFT) has attracted a lot of attention from financial trading professionals and the general public. The focus is on what this trading method could mean for the future. Italy recently taxed high-frequency trading (HFT) operations, and more people are calling for HFT to slow down. It affected all traders.
What Is High-Frequency Trading and How Important Is It?
High-frequency trading is automated trading in which trades are executed quickly, usually in milliseconds or microseconds. It has short hold times, small position sizes, and small profits per trade targeted.
Unfortunately, high-frequency trading is still a mystery, and the foreign exchange market is no different. There is little accurate and reliable information on the subject.
When thinking about it, it is important to remember that the stock market and Forex are fundamentally different. People should not draw conclusions about high-frequency trading in the foreign exchange market based on what they know about the stock market. The BIS study on HFT is an excellent, albeit somewhat outdated, introduction to this practice for people trading in the forex market.
Many Misconceptions About High Frequency Trading (HFT) Need to Be Dispelled
There are many myths surrounding high frequency trading. Let us list them and dispel them:
- HFT is inherently illegal because of the way it works. There are currently no rules that make high-frequency trading illegal, and it does not, by definition, involve any illegal activity (such as insider trading).
- High-frequency traders can use a special type of order that can self-cancel when a counterparty accepts it. High-frequency trading (HFT) does not have access to such orders. But they can do similar things, sending lots of small orders and reacting quickly to other traders’ movements.
- Significant hedge funds and investment banks are mostly into high frequency trading (HFT). They can make a lot of money in this lucrative market using their vast resources and advanced technological infrastructure. In fact, the opposite is true: it is mostly small specialized companies, not large financial institutions, that do high-frequency trading (HFT).
- In finance, high-frequency trading (HFT) is often seen as a low-risk approach. Both business experts and academics agree that this market has a high level of perceived risk. The main thing that makes the level of risk so high is that high-frequency traders must maintain a constant stream of incoming orders while tracking multiple orders. In terms of high-frequency trading processes, the importance of keeping the infrastructure up and running cannot be overstated.
How Does It Really Work?
The foreign exchange market (Forex) is heavily influenced by high frequency trading (HFT). A few facts on this subject will now be listed:
- Co-location. High-frequency trading (HFT) firms have a competitive edge because they can get stock prices a few microseconds before the rest of the buying public.
- The foreign exchange market (Forex) in general and high frequency trading (HFT) is self-regulating. This is regulated by the fact that the company implements robust risk management protocols, the broker closely monitors what is going on, and everyone abides by the rules of the trading floor.
- High frequency trading (HFT) can get information quickly from the liquidity provider about how prices are changing, even faster than large market makers using the same liquidity provider. This gives HFT an opportunity to capitalize on this information before the market maker has time to change prices.
- Most high frequency trading (HFT) techniques attempt to take advantage of good market conditions, such as plenty of liquidity and low volatility, that are considered appropriate for the market in general. But it is important to remember that not all HFT strategies follow this trend.
- High frequency trading (HFT) is only used by a small number of financial institutions for their own trading operations. HFT is not a big part of their overall business strategy.
- High frequency trading (HFT) people tend to use multi-bank electronic communication networks (ECNs) or well-known sites such as Reuters and EBS because they offer a wide range of trading opportunities.
- HFT firms play a critical role in ensuring liquidity is spread throughout the system and between different ECNs and platforms, because the Forex market is fragmented.
- As of April 2022, the spot forex market turnover that can be attributed to high-frequency traders is less than 25% of the total daily forex market volume, which is a staggering $7.5 trillion per day.
