High-frequency trading (HFT) is a type of algorithmic trading which uses advanced technological tools and computer algorithms to rapidly trade securities. With today’s technology, proprietary trading strategies can be carried out by computers to move in and out of trading positions in less than a second. High frequency trading is built on being able to trade extremely fast, and so the performance of strategies often relies on the processing speed of their trades in relation to the competition. In 2009, HFT accounted for 60-73% of all US equity trading volume, although that number then fell to approximately 50% in 2012 following some stability worries (more on that below).
Because of the sheer volume of trades made, and the speed at which buying turns to selling, high frequency trading strategies don’t need to – and don’t – make large profits with each trade. In fact, some trades can make as low as a penny or even a fraction of a penny each time. High frequency trading also doesn’t involve the use of leverage, and no positions are held, giving it a Sharpe ratio much higher than more traditional holding strategies (which denotes a far lower level of risk per trade).
Is HFT Dangerous For Markets?
While many traders have welcomed the advent of technology in finance, there are many others who believe HFT and electronic trading methods are putting severe strain on the markets. For example, Algorithmic trading, and particularly the high frequency type, were both found to have contributed to the extreme volatility witnessed in the so-called ‘Flash Crash’ of May 6, 2010, when worries about the debt crisis in Greece and the removal of liquidity providers from the market saw the Dow Jones drop 1,000 points in about 10 minutes. Thankfully, the same technologies presumably helped it recover again just 20 minutes later!