An Overview of High-Frequency Trading and Its Impact on Financial Markets

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high frequency trading
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What is High-Frequency Trading?

High-speed trade execution, a staggering volume of transactions, and a relatively short investment horizon are all characteristics of high-frequency trading (HFT). High-frequency trading is an extension of algorithmic trading within quantitative finance. HFT uses specialised computers to execute trades as quickly as feasible. Due to its complexity, it is usually used by large institutional investors like hedge funds and investment firms.

High-frequency trading employs sophisticated algorithms that examine individual equities in milliseconds to identify new patterns. If the analysis discovers a trigger, it will trigger hundreds of buy orders to be despatched in a brief amount of time.

Institutions that use high-frequency trading can get favourable returns on transactions they execute by virtue of their bid-ask spread, resulting in huge profits. This is accomplished by essentially predicting and beating the trends to the market.

Following the advent of incentives provided by exchanges for institutions to supply liquidity to the markets, high-frequency trading became more widespread.

Exchanges improve their liquidity by providing tiny incentives to these market makers, and the institutions that supply the liquidity benefit more from each deal they execute in addition to enjoying advantageous spreads.

Benefits of High-Frequency Trading    

·      Trading securities in high volume and at high frequency enables investors to profit from even the smallest price changes. Institutions are able to profit significantly from bid-ask spreads thanks to it.

·      Multiple marketplaces and exchanges can be searched using high-frequency trading algorithms. By arbitraging small price discrepancies for the same asset that are traded on many exchanges, it helps investors to locate new trading opportunities.

·      High-frequency trading is supported by many as it improves market liquidity. HFT unmistakably promotes market competitiveness since trades are carried out more quickly and in greater volume. The markets become more price-efficient as a result of the decreased bid-ask spreads brought on by the increased liquidity.

·      Since there is always someone on the opposing side of a trade, a liquid market has lower risk.

Impact on Financial Markets

High-frequency trading is criticised by some industry experts because they think it unfairly favours large corporations and tilts the playing field. It may also be detrimental to other investors that have a long-term plan and make large purchases or sales.

Additionally, critics contend that market volatility is influenced by new technology and computerised trading, which began in the early 2000s. By mass selling their assets in response to precise market indications, such technology can amplify both small and huge crashes.

High-frequency traders profit from any imbalance between supply and demand by taking advantage of arbitrage and speed. Their transactions are driven by opportunities rather than in-depth analysis of the company or its development potential.

Despite the fact that HFT doesn’t have a specific objective, it can harm both institutional and ordinary investors, including mutual funds that make large purchases and sales.

The businesses that use HFT are typically large hedge funds, stockbrokers, and investment and wealth management firms.