High-frequency trading (HFT) describes trading that require high computing and communication speeds.
HFT is characterized by high communication and computing speed, large number of trades, low profit per trade and expensive software infrastructure.
High-frequency traders use communication speed to profit and outwit other traders.
Main article: Arbitrage
Arbitrage trades happen when an asset is priced differently on 2 exchanges and a trader buys the cheaper one while shorting the pricier one.
Reaction to news
When a major news is released, the trader who reacts the fastest wins. In this case, the high-frequency trader needs to analyze the news and fire the trade before everyone else
When a traditional (slower) hedge fund buys a large amount of Stock A, a HFT hedge fund will detect that.
The HFT hedge fund will then buy all the Stock A on the other exchanges and sell it back to the slower hedge fund for a small profit.
The HFT hedge fund might do this millions of times over a day.
A large number of similar stocks might move in a similar manner. When any of the stocks diverge, the high-frequency trader will buy the cheaper one and/or short the pricier one.
An index or exchange-traded fund is designed to track the returns of an index such as the S&P500.
HFT is a secretive field. Once a strategy is revealed and the other funds join in, the profit opportunity disappears fast.
Thus, many new strategies are innovated everyday and are not known to the general public.
Investment in infrastructure
HFT funds spend hundreds of millions on hardware and software infrastructure to reduce their computing and communication speed by the milliseconds.
Since relative speed is more important than absolute speed, HFT funds constantly try to be faster than their rivals.
Investments in infrastructure includes building a straight tunnel to lay communication lines and shifting their servers right beside the exchange’s servers.
Examples of Popular High-Frequency Firms
- Virtu Financial
- Citadel Securities
- Two Sigma Securities
- Tower Research Capital
Links to Complicated Explanations
- Statistical Arbitrage (Coming soon)
- Exchange-traded fund (Coming soon)
- Machine Learning