HFT

Introduction

HFT is a special category of algorithmic trading characterized by holding period of securities ranging from microseconds to a few minutes. HFT requires powerful computers and excellent network architecture to transact with data at very high speeds. HFT needs to have low-latency response times and high trading volumesfor it work successfully. HFT also requires Tick-by tick data and good understanding of market microstructure. HFT strategies are mainly divided into market making, statistical arbitrage, and quantitative low latency strategies. 

 

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Working of High Frequency Trading (HFT)

HFT is a type of trading that works to execute large volumes of the trade orders within microseconds or even lesser. 

Hence, HFT captures the profitable opportunities during the price fluctuations based on the trading parameters set by the trader.

 

The entire execution process is conducted by artificial intelligence which is coded with the preferred trade related instructions or the parameters. 

 

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Advantages of High Frequency Trading (HFT)

 

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High Frequency Trading (HFT) strategies

 

Let us see some of the most popular high frequency trading strategies, and these are-

 

• Market making - A market maker is an individual, professional trading firm or a brokerage firm that is prepared to buy or sell securities on a continuous basis at a publicly quoted price to provide liquidity to the market. Market makers quote on both the buy and the sell side simultaneously. 

For example, in a High frequency trading strategy (HFT), a trader will bid for a stock at  $40 and keep the ask at $40.20. In this manner, when both bid-ask orders are filled,  the profit earned will be $0.20. 

 

• Statistical arbitrage - Stat Arb is a trading strategy based on the statistical mispricing of one or more assets compared to the expected future value of the assets. Stat Arb algorithms monitor financial instruments that are historically known to be statistically correlated or cointegrated, and any deviations in the relationship indicate trading opportunities.

For example, once the high frequency trader conducts a co-integration test (ADF test) and finds out a pair of stocks that can be paired for trading, the trader can use the stat-arb strategy. In this example, let us take Tesla (TSLA) and Google (GOOGL) as the co-integrated stocks. Let us assume that the price of the Tesla (TSLA) is undervalued and Google (GOOGL) is overvalued. According to the statistical arbitrage strategy, the trader will go long on Tesla (TSLA) and will short Google (GOOGL).

 

• Tick trading - A tick can also refer to the change in the price of security from trade to trade.

Let us assume you are a liquidity provider and every time you improve the bid-ask quote, somebody is going to be ahead of you. By one tick. Not more, just one tick. While you wanted to buy the asset at $150.02, the HFT placed a bid at $150.03.

 

For example, if a stock, Apple (AAPL) has the tick size of $0.01, and the last price that was traded (LTP) was $50. The best bid is $50 and best ask is $50.04. The high frequency trader will place a bid at $50.01, just one tick above the best bid. Once this order is filled, the HFT will place a sell order at $50.03, just one tick below the best ask. Since the HFT’s order is the best ask price, it will get filled immediately and the HFT will earn a profit.