Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 69% of retail investor accounts lose money when spread betting and/or trading CFDs with this provider. You should consider whether you understand how spread bets, CFDs, OTC options or any of our other products work and whether you can afford to take the high risk of losing your money.

High-frequency trading

High-frequency trading is a method of fast-paced algorithmic trading​ that uses computer programs to potentially initiate many trades at once or millions of trades per day. High-frequency trading utilises a very short-time frame of often seconds and attempts to make micro profits many times a day, or even per minute.

High-frequency trading requires a powerful computer, ultra-high-speed internet, complex algorithmic trading software, and servers that are often located near an exchange. For this reason, high-frequency trading is practiced by large financial institutions, including market makers and hedge funds. This type of trading can also be done by individuals on a smaller scale. High-frequency trading affects all retail traders in ways that they may not be aware of. Learn more about our institutional accounts​.

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What is high-frequency trading?

High-frequency trading (HFT) is a short-term trading strategy that aims to capture small profits with large position sizes. It affects all market participants, whether they themselves are high-frequency traders or not. Many of the orders that are executed in a marketplace, plus the bid-ask spreads​​ that are seen, are the result of high-frequency traders.

Placing several orders a second, let alone hundreds or thousands, is outside of manual human capabilities. Yet a computer, instructed through a program to place orders or buy and sell in various markets, such as stocks, commodities, currencies and bonds, can easily accomplish this task. That is what HFT represents: primarily computer-driven bids, offers, and transactions with the programmed intent of capturing small profits from the financial markets​.

HFT firms are companies that specialise in this form of trading. Since they trade so frequently, all traders have likely transacted with a HFT firm at some point.

High-frequency trading signals

Traders cannot usually detect HFT because it happens at such a high speed, where the algorithms can pick up on trading signals and execute multiple orders within a fraction of a second. Some high-frequency trades you spot are often illegal. For example, you may see large orders being posted on the bid or ask in an attempt to manipulate the market​ price, yet these orders are cancelled before they are filled.

You may also get a better price on an order than expected. This tends to happen more in the stock market​ than other markets. This could also be high-frequency traders trying to step ahead of other market participants.

High-frequency trading: algorithmic strategies

HFT is algorithm based. The algorithm is designed by a programmer to take advantage of profit opportunities in the market. Here are several of the profit opportunities that it may look for:

  • Tracking orders: Complex algorithms can track the properties attached to orders placed in the market. This may reveal the real intent of traders. For example, orders left out overnight are likely from real people who want to buy or sell that security. An order that is frequently cancelled or altered tells the algorithm the order is from an active day or other high-frequency trader. These active traders are likely willing to go long or short and use brief chart timeframes. By comparing all these orders, an algorithm may be able to sort out which way the price is likely to move.
  • News or event HFT: Algorithms can be programmed to read news and look for specific words. It can read faster than a human and also place orders faster. If news hits, a HFT strategy is to calculate the projected effect of the news and then buy or sell ahead of others, all in a rapid timeframe. Learn more about event-based trading.
  • Statistical arbitrage: This is when one security moves away from its typical correlation with another security. Perhaps an ETF is overvalued compared to the index that it tracks. Algorithms may short the ETF and then buy the index to exploit the difference.
  • Index arbitrage: This is not limited to high-frequency traders as retail investors do it as well. When a stock is added to an index, the index needs to buy shares of that stock. High-frequency traders and retail traders buy the stock, hoping to catch the rally that may occur when the index starts buying.

These are some of the general strategies that high-frequency traders employ. There are as many algorithms as there are traders who employ them, with each one being slightly different.

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High frequency trading examples

FX High-frequency trading

HFT in the forex market​ is common. Institutions and hedge funds may also look for triangular arbitrage. This occurs when one pair is slightly mispriced relative to other pairs. For example, the EUR/USD and USD/CHF have their prices, which then implies a rate for the EUR/CHF. If the EUR/CHF has a slightly different price than what is implied by the others, there is an opportunity for profit. Algorithms will search for triangular arbitrage then exploit it when possible.

High-frequency commodity trading

High-frequency trading also occurs in the commodity markets​. A common tactic for high-frequency traders in the commodity market is to take advantage of mispricing between markets. For example, if commodities are priced in different currencies on different exchanges, an algorithm may be able to exploit tiny price differences due to the exchange-rate fluctuations. Alternatively, if a commodity is priced in the same currency, even very small price differences can be exploited by selling the over-priced contract and buying the under-priced contract.

Dark pools and high-frequency trading

Dark pools are private exchanges where market orders are not posted publicly, unlike typical orders that appear on the order book of any market. Dark pools allow institutional traders to transact in large quantities of securities without affecting the orders on the book. Orders on the book control the price, but there is often a limited quantity of securities on the order book at each price level.

High-frequency traders can use dark pools to attain or dispose of their financial instruments when possible. For example, if an algorithm can buy on the bid and then sell to a dark pool at the midpoint, they net half the bid-ask spread, less their fees. If an algorithm has accumulated a position, a dark pool may provide an easy exit that does not affect the price.

Advantages of high-frequency trading

  • HFT can provide rapid profits often with little risk as orders are executed simultaneously to lock in price discrepancies.
  • HFT can provide an edge in terms of speed allowing high-frequency traders to snag advantageous prices ahead of the crowd
  • HFT helps to bring added liquidity to markets, which is usually preferred by most traders.

Disadvantages of high-frequency trading

  • While advocates say HFT brings added liquidity to the market, critics say that liquidity is unlikely to be there when the market really needs it since HFT firms are unlikely to buy when prices are rapidly plunging, for example.
  • HFT requires a large amount of money, often leveraged​, to make the tiny profits worthwhile.
  • HFT requires capital investment upfront for computing power, high-speed connections and servers, plus programming costs and time.
  • HFT has been blamed for ‘flash crashes’. When an algorithm becomes erratic, this results in the algorithm selling rapidly, temporarily, and often briefly, which can lead an asset’s price to plunge.
  • With the ability to post millions of orders per second, there is greater potential for illegal behaviour, including posting orders that are never intended to be filled and manipulation of the order book.
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How to start high-frequency trading

What is referred to as high-frequency trading in the media involves large amounts of capital, direct access to exchanges, vast computing power, often co-location, fibre-optic internet connections, and PhD-level programmers and researchers. These requirements are similar to quantitative trading​.

HFT is usually reserved for institutional investors, such as our CMC Connect platform. Retail investors can execute automated trading strategies. An automated strategy places trades quicker than a human and can be programmed based on any rule-based strategy. A trader can write code to create an Expert Advisor (EA) or application programming interface (API) that connects to their trading platform and trades on their behalf. This is not on a similar scale to high-frequency firms, but it is a similar alternative.

High-frequency trading software

High-frequency trading firms will often write their own software, but retail traders can use existing software to write code and execute their trading strategies. Expert advisors are available to buy and create in MetaTrader4 (MT4)​, a globally used trading platform that is available on our software. An EA is a program in the platform that executes coded strategies for algorithmic trading. Traders write code in the MetaQuotes language, known as MQL4, which is then executed on the MT4 platform. Register for an account to start practising and download MetaTrader 4​ here.

Some other trading platforms will have an API connection, which allows an external program to be connected to the trading software. The API can be programmed to analyse markets or trade according to coded rules.

AI in high-frequency trading

Artificial intelligence (AI) is a disputed part of HFT. While learning algorithms are prevalent in many sectors of the economy, the HFT community is split on whether this is beneficial. Traditionally, HFT firms have made money based on defined computations and strategies, often winning small profits with well-defined rule-based strategies.

AI is about learning and acting more human in a way. While this may work, it also brings with it the need for increased computer power and unknown risks when it comes to how the AI will learn and act. How will it act when it interprets something it has never “seen” before? This creates risks, as well as opportunities.

Is high-frequency trading ethical?

High-frequency trading is highly debated and charges have been levelled against many HFT firms for illegal activities. The argument for HFT is that, in most cases, it provides substantial trading volume and liquidity to the market. This means that retail traders are more likely to have someone to buy from or sell to when needed.

Despite this advantage, high-frequency traders often profit from providing trading volume. They can execute orders quicker than others, providing what some view as an unfair advantage. At the same time, HFT helps to keep markets in line by exploiting small price differences and bringing disconnected assets back into equilibrium.

A retail trader that is not interested in high-frequency trading simply needs to develop a trading strategy that looks at a slightly longer timeframe. Consult our article to the most common and effective trading strategies​. Traders can deploy scalping strategies where trades last several minutes, or trend following strategies where trades last minutes or weeks. These strategies are not typically in direct conflict with HFT. Momentum trading involves jumping into assets that are moving strongly. If the price is soaring, it does so regardless of the HFT; therefore, retails traders can capitalise.

With all strategies, there is also risk. No matter what method of trading is employed, stop-loss orders​ can be placed to help control this risk and manage position size, so that if the stop-loss is triggered, it only results in losing a small portion of the trading account. However, stop-losses are not always effective, even GSLOs, therefore other risk management practises should also be taken into consideration.

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Disclaimer: CMC Markets is an execution-only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although we are not specifically prevented from dealing before providing this material, we do not seek to take advantage of the material prior to its dissemination.

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