Understanding High-Frequency Trading

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Contributor, Benzinga
June 13, 2023

High-frequency trading (HFT) is a type of investing that relies heavily on the use of algorithms to scan the market and capitalize on small, frequent trades. This style of trading relies on powerful computers to scan multiple markets to identify pre-defined conditions and execute trades based on instructions from the investor. HFT can be complicated but is also important to overall market liquidity. 

Interested in learning more about HFT and who it is best for? Read on to learn more about the benefits of HFT and what you should know before exploring HFT firms. 

What is High-Frequency Trading?

High-frequency trading (HFT) is a method of automated, algorithm-assisted trading that uses top-of-the-line tech to identify market opportunities and patterns faster than a human. These algorithms are able to scan the market, locate an opportunity and execute a buy or sell order in a second or less. 

HFT algorithms continuously monitor various sources of market data, such as price quotes and options order books. These data sources provide information about current market conditions and price movements. The trader directing the HFT defines the conditions that the algorithm should detect in real-time. Most HFT strategies direct the algorithm to search for items like price discrepancies and charting patterns that may indicate short-term profit opportunities. 

When the HFT algorithm identifies a trading opportunity, it generates and submits trade orders to the market. These orders are typically executed within microseconds or even nanoseconds, thanks to the ultra-fast trading infrastructure employed by HFT firms. The algorithms can place orders to buy or sell securities, often in large volumes, using the capital supplied by the firm. 

Benefits of High-Frequency Trading

While HFT firms are subject to some market debate, they may offer a number of benefits to individual retail investors and the overall value-investing market as a whole. 

Improved Market Efficiency 

HFT algorithms are designed to analyze vast amounts of market data in real time. By processing this information quickly, HFT can swiftly incorporate new data releases, news or other market events into prices. This feature helps ensure that market prices more accurately reflect the available information, benefiting you as a retail investor. Thanks to improved market efficiency, retail investors are less likely to buy a stock at a price that doesn’t reflect its true value. 

This process is often referred to as “improved price discovery.” Price discovery is the process by which market participants determine the fair value of stocks and exchange-traded funds (ETFs) based on supply and demand dynamics. By identifying and capitalizing on thousands of small discrepancies between pricing data, HFT helps correct pricing inefficiencies, thereby improving overall market efficiency.

Increased Liquidity 

Proponents of HFT also argue that it provides improved overall market liquidity, which benefits all investors by reducing bid-ask spreads. HFT firms operate with automated trading systems that are active in the market throughout trading hours. These systems continuously monitor market conditions and are always ready to execute trades. 

By maintaining a constant presence, HFT firms provide a continuous stream of buy and sell orders, thereby increasing overall liquidity. When you place an order to sell an asset, for example, someone who owns the asset must be willing to sell it for the order to be completed. In most cases, the “someone” buying or selling the order is now an algorithm. This enhanced liquidity can be beneficial for swing traders and scalpers as well, as it provides the possibility for major trades to be executed instantly. 

This liquidity also lowers the bid-ask spread between asset prices, which is another benefit for traders who use short-term investment strategies. Bid-ask spreads represent the difference between the highest price a buyer is willing to pay (bid) and the lowest price a seller is willing to accept (ask). HFT firms often place competitive bids and offers, which reduces the spread between the bid and ask prices. Narrower spreads mean that securities can be bought at slightly lower prices and sold at slightly higher prices, benefiting all market participants.

Better Technology for Firms and Investors

HFT firms and the competition among them have brought significant technological advancements to the overall market, which has had several positive impacts for retail investors. These firms' emphasis on executing trades quickly has driven advancements in low-latency networks, reducing the time it takes for data to travel from one point to another. This interest has provided retail investors with improved access to market connectivity. 

HFT firms invest in co-location services, which involve locating their trading servers in close proximity to exchange data centers. This proximity reduces latency and enables faster access to market data and order execution. These advancements have also facilitated the growth of electronic trading, enabling greater participation and enhancing market efficiency even further. 

Considerations for High-Frequency Traders

HFTs and the firms that employ this technology are not without controversy. Be sure to consider the following objections to HFT before getting involved in the market. 

Unequal Access to Market Resources

HFT's use of advanced technology and high-speed connections can create a disparity in market access. HFT firms with significant financial resources and sophisticated infrastructure may have an advantage over smaller market participants who cannot afford the same level of technological investment. This inequality of access raises concerns about fair and equal market participation.

Artificially High Market Volatility

HFT's rapid trading and high trading volumes can contribute to higher market volatility, making prices fluctuate more often than is natural. The use of algorithms that react to short-term price movements or market conditions can lead to sudden price fluctuations or rapid changes in liquidity. Critics argue that this increased volatility can disrupt market stability and impact the confidence of investors.

Potential for Market Abuse and Manipulation

The speed and complexity of HFT strategies have raised concerns about potential market abuse and manipulation. There have been instances where HFT firms have been accused of engaging in manipulative practices, such as front-running (prioritizing their own trades ahead of others) or creating artificial price movements to trigger stop-loss orders.

Who Should Try High-Frequency Trading?

While not a suitable strategy for everyone, HFT can benefit a few types of traders. 

  • Institutional investors: Institutional investors, such as hedge funds, proprietary trading firms and asset management companies, often have the necessary resources and expertise to engage in HFT. They may have dedicated quantitative trading teams, access to cutting-edge technology and a deep understanding of market dynamics and portfolio management needed to be successful.
  • Market-making firms: Market-making firms play a crucial role in providing liquidity to the market, continuously facilitating trading and improving market efficiency. HFT strategies, with their ability to rapidly analyze market data and execute trades, can be particularly suitable for market-making firms.
  • Experienced individual traders and quantitative analysts: Traders and quantitative analysts with a strong background in mathematics, statistics and computer programming may consider exploring HFT. Their expertise in developing and implementing complex trading algorithms can be valuable in designing effective HFT strategies.

Exploring the Strategies of High-Frequency Trading

High-frequency trading (HFT) is a type of investing strategy that uses advanced algorithms and computers to make rapid trades in the financial markets. HFT involves constantly scanning for opportunities in the markets and executing orders based on pre-defined conditions at speeds far faster than what humans can do manually. By taking advantage of small price movements, traders using HFT strategies aim to maximize profits through frequent trades.

Frequently Asked Questions


Is high-frequency trading profitable?


HFT can be profitable for firms that have the necessary resources to identify and execute small price movement strategies. However, it’s important to know that individual HFT participants should be well-versed in quantitative analysis to be successful on the market, as they must compete against market-making firms.


Is high-frequency trading a legit strategy?


Yes, high-frequency trading is a legitimate trading strategy employed by many financial institutions and professional traders.


Is high frequency trading illegal?


No, high frequency trading is not illegal. High frequency trading (HFT) is a type of automated trading that uses complex algorithms and high-speed computer systems to buy and sell stocks, options, and other financial instruments.

Sarah Horvath

About Sarah Horvath

Sarah Horvath is a seasoned financial writer with a specialization in investing content. With a keen eye for market trends and a deep understanding of investment strategies, Sarah delivers insightful and informative articles tailored to investors. Her dedication to providing valuable content empowers readers to make informed decisions in the dynamic world of finance. Sarah’s expertise extends across various investment vehicles, including stocks, bonds, cryptocurrencies, and real estate. Whether analyzing market movements, evaluating investment opportunities, or demystifying complex financial concepts, Sarah’s writing is characterized by clarity, accuracy, and actionable insights. Through her engaging content, Sarah strives to educate and guide investors on their journey towards financial success.