What Is High-Frequency Trading (HFT)? How It Works and Example

What Is High-Frequency Trading (HFT)?

High-frequency trading (HFT) is a trading method that uses powerful computer programs to transact a large number of orders in fractions of a second. HFT uses complex algorithms to analyze multiple markets and execute orders based on market conditions. Traders with the fastest execution speeds are generally more profitable than those with slower execution speeds. HFT is also characterized by high turnover rates and order-to-trade ratios.

• HFT is complex algorithmic trading in which large numbers of orders are executed within seconds.
• It adds liquidity to the markets and eliminates small bid-ask spreads.
• HFT is criticized for allowing large companies to gain an upper hand in trading.
• Another complaint is that the liquidity produced by this type of trading is momentary—it disappears within seconds, making it impossible for traders to take advantage of it.Understanding High-Frequency Trading (HFT)High-frequency trading is a type of algorithmic trading. Traders are able to use HFT when they analyze important data to make decisions and complete trades in a matter of a few seconds. HFT facilitates large volumes of trades in a short amount of time while keeping track of market movements and identifying arbitrage opportunities.Some of the key characteristics of high-frequency trading include:

• Trading at high speeds
• A large number of transactions executed
• Short-term investment horizons

Because of the complexities and intricacies involved with HFT, it isn't surprising that it is commonly used by banks, other financial institutions, and institutional investors.

It became popular when exchanges started to offer incentives for companies to add liquidity to the market. For instance, the New York Stock Exchange (NYSE) has a group of liquidity providers called supplemental liquidity providers (SLPs) that attempts to add competition and liquidity for existing quotes on the exchange.