What is high-frequency trading?
High-frequency trading (HFT) refers to the use of technology to automatically execute high volumes of transactions within narrow time frames. In order to achieve the high speeds that are needed for this type of trading, traders need access to sufficient computing power, high-frequency trading software, and complex algorithms that enable the opening and closing of positions within microseconds.
The best traders use dedicated microwave towers to transmit and analyze order information, where microseconds can make the difference in having a headstart over the public. HFT systems are often co-located or in close proximity to the broker's data centers where their servers are located, in order to minimize any potential latency or delay between the time their orders are submitted and when they are executed or canceled.
HFT systems are also notorious for canceling and replacing orders at a high rate of speed, and other practices that can otherwise disturb or spoof normal markets. One such example would be the practice of front running, in which an HFT system attempts to sprint ahead of a large order of assets or shares on an exchange. If the HFT system is able to move fast enough, it can turn around and sell (or buy) the assets to the client it was racing against.
Over the last 20 years, many rules and regulations have been put in place to help uphold market integrity, protect market participants, and prevent practices like front-running. HFT does provide some benefits to the markets, such as added liquidity, and retail traders themselves are not running their own HFT systems.
Speed versus cost: Some HFT strategies are not as time-sensitive, and might be more dependent on low trading costs (such as lower effective spreads) in order to be effective.
Other simpler strategies instead rely mostly upon technical analysis. For example, when certain pre-determined conditions are met, an order might be triggered to open a new trade or to close an existing one. Not all HFT strategies place large numbers of orders each day (or even every week). Rather than speed, the crucial factor is the logic being used to specify the conditions that must be met to trigger an order.
Pros & Cons of high-frequency trading:
- Be first out of the gate. High-frequency traders are often able to take first-mover advantage in high-impact news situations, such as GDP and inflation data releases, nonfarm payrolls, and monetary policy announcements.
- Technology is unemotional. This rapid large-scale trading is carried out by computers, so HFT strategies are not subject to the pitfalls and mistakes that can be caused by the influence of human emotions.
- Market efficiency. In a big-picture sense, HFT can help markets become more efficient by increasing available liquidity, and by reducing spreads as arbitrage opportunities are removed.
- It’s not easy. When used by retail and professional clients, HFT strategies require a high degree of technical skill, experience, and attention, including during the setup, monitoring, and overall management phases.
- Computer intelligence only goes so far... While it may seem like a no-brainer to remove the human component from trading, computers aren’t perfect either. They may not always react appropriately to volatile market conditions or make distinctions between genuine and false news events.
- …and a technological “ceiling” isn’t all that far off. Looking into the future, there is almost certainly a limit to how much more these high-powered computing systems can advance. Simultaneously, market technology is accelerating, allowing for price disparities to be identified and rectified before high-frequency traders can exploit them.
Can you make money with high-frequency trading?
Yes, but your overall profitability when trading – regardless of your trading strategy – is dependent on a variety of factors, such as the size and number of trades you are making. Just because an HFT strategy uses fancy Python code or was developed by a Harvard quant doesn’t mean it will be profitable. Likewise, a simple moving average cross-over strategy or a similarly straightforward HFT system shouldn’t be dismissed for its simplicity.
Traders who hope to achieve long-term profitability need to manage their risk/reward ratio, keep their average profits higher than average losses, and maintain a win/loss ratio that results in a net overall profit (though of course, this is easier said than done). The challenge in developing an effective strategy – including for an HFT system – is determining how and when to enter and exit the market, and how to adapt to changes in your outlook or overall market conditions.
Pro tip: The best HFT system developers will back-test their system on out-of-sample data (data that the system is not privy to) – such as historical data – to avoid curve-fitting the system to the results. The results of that backtest will show how the system would have hypothetically performed over that historical time frame.
If the results look promising, they can then be forward-tested using real-time (current) market data and live trading conditions, to see if those results are similar to the hypothetical backtested version. Successful HFT developers will undergo these tests before scaling or fully funding an HFT strategy.
What is arbitrage?
Arbitrage (also known as scalping) describes a trading strategy in which an asset is bought in one market with the intention of turning around and instantly (or, near-simultaneously) selling that same asset in a different market or venue. Traders that engage in arbitrage are attempting to exploit the often-minuscule price discrepancies that may exist between the two markets or venues.
A latency-driven arbitrage strategy can involve prices that lag by a few milliseconds due to a technical glitch or slow server, for example, or simply come as a result of market fragmentation. For the latter, arbitrage doesn’t result from price lag, the rate simply varies across different venues within centralized exchanges (such as forex markets).
Today, as financial markets increase their efficiency and interconnectedness, arbitrage opportunities have become harder to detect, more fleeting, and ultimately rarer. It’s now more difficult for even the best HFT systems to monetize any off-market prices. Market efficiency has also resulted in tightened spreads and commissions. As market makers and proprietary trading firms carry out arbitrage, they increase the available market liquidity for the public while competing against each other to capture the spread.
It’s also important to note that some venues prohibit latency-only strategies because of their potential for causing conflicts of interest. For example, a market maker could be incentivized to “create” an arbitrage event by front-running their own customer in order to make a profit at the client’s expense. Therefore, if you are attempting to capture some form of arbitrage, it is important to find out whether your broker has any anti-latency arbitrage mechanisms in place, or if it permits scalping.
Inter-market arbitrage: Arbitrage can also exist across instrument types for an underlying asset, such as between the forex cash (spot) market and forex futures markets, or between a forex derivative and underlying forex-related security, known as intra-market arbitrage.
Stat arb: With statistical arbitrage (or, stat arb), traders track the correlation of multiple assets and attempt arbitrage when there is a deviation from the normal course of price action and traders have an expectation that it will return to a normal baseline. In such cases, arbitrage can involve more than two markets, such as with triangular arbitrage, or the use of three orders that are sent as a single multi-legged order.
Is high-frequency forex trading legal?
High-frequency trading is legal, but that doesn’t necessarily mean that it will be permitted by your broker. It’s important to examine your broker’s terms and conditions to determine whether its defined trading conditions will allow for HFT strategies. Some brokers prohibit strategies that are price-driven (such as with scalping) or latency-driven arbitrage strategies.
That being said, there are brokers that may welcome such trading. In these cases, it’s wise to pay attention to the specific trading conditions being offered, such as execution methods and related trading costs. You’ll have to determine whether HFT is a feasible strategy under such conditions.
HFT systems must be prepared to handle any and all potential market conditions and brokerage account scenarios with established methods in place to resolve such events, in order to avoid stalling or causing errors that could lead to significant losses.
For example, if a broker re-quotes an order due to a price change that occurred before the order was placed, an HFT strategy may not be able to act on that re-quoted price unless it is supported in the broker's API or related trading platform, such as MetaTrader.
On the other hand, if the broker offers you a “market” execution method, it means that orders are never rejected, but can be subject to a worse price fill. In this case, an HFT strategy must be able to set a deviation parameter to minimize the potential for excessive slippage. Without that parameter, it would be difficult to manage the risk on a position if slippage cannot be minimized during fast market conditions – especially if your HFT strategy is carrying out a high number of trades.
Is high-frequency trading profitable?
Whether an HFT strategy will be profitable for you (or not) will depend on a variety of factors, such as your individual system configurations (and whether you’ve chosen the right HFT). On a high level, it’s always important to remember that the majority of retail forex traders lose money, so the odds are against you from the start. Short-term trading in the stock market can also be less profitable than longer-term investing.
That all being said, if you are looking to pursue a HFT strategy, there are a few factors to consider if you want to maximize your chances at profitability:
Choosing the right HFT system: The market is saturated with HFT systems, including for retail traders. There are thousands of HFT programs available from third-party developers (such as on the MetaTrader MQL5 community) available for lease via subscription or for indefinite use. However, the efficacy of these programs will depend on a number of factors, such as the quality of their historical data and the actual live trading results.
HFT system configuration: Even the best HFT systems require some initial configuration when you initialize them, such as choosing the values for adjustable parameters and selecting which markets to trade.
A single HFT system could potentially be configured in hundreds or even thousands of ways. There may be dozens of variables, each with multiple values that can be calibrated differently each time it’s used. It’s important to note that the parameters are sometimes over-optimized, or even configured on historical data to maximize “results” so that the system developer can promote the strategy. That system, however, may perform differently in real market conditions.
Pro tip: The key to making money with HFT is to use a system that is properly configured and tested with real results for a sufficient period of time, before scaling your portfolio allocations towards such a strategy. It’s also crucial to figure out how to adjust the system parameters to adapt to changing market conditions, for risk management purposes.
Which broker is best for HFT trading?
The best broker for high-frequency trading in 2024 is IC Markets. IC Markets has everything that a trader running an HFT strategy might need, offering a liberal execution policy (including during fast markets), numerous account types, and a variety of execution methods., All of these features, along with its deep liquidity, has us ranking IC Markets at the top for HFT traders.
If you are running an automated trading system that trades at lower frequencies, for example, or an ultra-fast HFT setup, IC Markets’ support for the complete MetaTrader suite (MT4 and MT5) has you covered. Also available with IC Markets is the cTrader platform suite, which supports FIX API trading connectivity.
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