High-frequency trading meaning
High-frequency trading is a trading strategy that uses complex algorithms to execute a large number of trades in fractions of a second.
What Is High-Frequency Trading?
High-frequency trading (HFT) refers to a trading method that uses algorithms to analyze crypto market data and perform a large number of transactions within a short timeframe. Technically, it is a subset of algorithmic trading – a method of using advanced mathematical models to automatically place buy and sell orders in a crypto market.
HFT aims to capture small gains with each trade, which accumulate into significant gains over time. Since the decision-making of the orders to execute can occur within fractions of a second, automated bots or algorithms are used to enter and exit positions swiftly.
Given the complex algorithms used, HFT is often used by institutional investors. And while it allows market participants to leverage price fluctuations before they are reflected in the order book, it eliminates human decision-making and interaction. In addition, the fast transactions involved can potentially lead to major market moves.
How Does HFT Work?
HFT works on the principle of buying low and selling high. To achieve this, HFT algorithms analyze vast amounts of market data across multiple exchanges within milliseconds. These algorithms are designed to continuously identify patterns, trends, and the smallest price changes, among other subtle trading triggers.
The HFT system uses this analysis to automatically execute a large number of transactions in quick succession, typically capitalizing on the smallest price difference detected by the algorithm. That said, HFT systems use their ability to identify or predict shifts in trading volume and trajectory of institutional order flow to execute arbitrage, market making, and volume trading tactics.
For example, when a whale or large investor enters or exits a position on a certain crypto, the cryptocurrency’s value usually fluctuates. Specifically, the cryptocurrency’s price often drops when the whale sells their holdings. The HFT algorithm will quickly “buy the dip” and close the position once the cryptocurrency’s price recovers.
In short, HFT is the first in line to exploit any bid-ask spread immediately after the algorithm identifies an opportunity. This act typically removes high bid-ask spreads and offers a continuous flow of liquidity, thereby enhancing market conditions. Some exchanges even offer rebates and low fees for HFT providers to incentivize high-frequency trading.
