High Frequency Trading is a term used to describe a group of trading methods that incorporate high levels of automation into the buying and selling of securities where large volume trades are executed in seconds or fractions of seconds.
One way to think of high frequency trading is to think about the difference between writing a letter and sending an instant message. When you write a letter, you try to cover a lot of bases by conveying as much detail and meaning as you can because what's happening at the time you write the letter could easily be different once your friend receives it. To reduce the effects of this time delay, you involve your computer or your smartphone and send an instant message. Tweeting or texting require a lot less when it comes to word choice because you can send thousands of messages in sequence and in the end, your friend will know what you're talking about. High frequency trading strategies attempt to do something similar for securities traders, as computers are used to make trades at specific points based on conditions that are predetermined by the trader.
So We're Letting Computers Handle Our Money?
In a way, yes. Most transactions that are processed today are handled electronically, simply because computers can more efficiently process large amounts of data at speed. High frequency traders use complex computer models to analyze a vast array of market conditions in real-time and make trades that can occur in seconds or between seconds depending on what a given trader is looking for. So in this sense, computers are the processing agents for the buy and sell orders but human traders are supplying the when, where and how much.
What Does High Frequency Trading Look Like?
High Frequency trading is generally defined by the following characteristics:
- uses computer software to analyze incoming market data and conduct trades based on this data.
- trades remain open for very short periods, usually from hours down to fractions of seconds. Trading occurs very rapidly often trading thousands to tens of thousands of trades each trading day
- High frequency traders usually do not have any positions open at the end of a given trading day.
- Relies heavily on the processing capability of computers to find, analyze relevant market data.
There are also different types of high frequency trading:
- Market Making: places buy or sell orders on various securities in order to earn it's bid-ask spread, thus creating a new market by acting as a counterparty to incoming market orders.
- Ticker tape trading: uses fast processing computers to analyze ticker quotes and volumes to glean information that has yet to be reported.
- Event arbitrage: using recurring events and past price history to forecast short-term market moves and profit accordingly
- Statistical arbitrage: an HFT strategy that attempts to take advantage of predictable deviatiions in "stable statistical relationships" between securities.
Why Trade At Such High Speeds?