High-frequency trading (HFT) is an automated trading platform used by large investment banks, hedge funds and institutional investors that utilizes powerful computers to transact a large number of orders at extremely high speeds. These high-frequency trading platforms allow traders to execute millions of orders and scan multiple markets and exchanges in a matter of seconds, thus giving the institutions that use the platforms a huge advantage in the open market.

The systems use complex algorithms to analyze the markets and are able to spot emerging trends in a fraction of a second. By being able to recognize shifts in the marketplace, the trading systems send hundreds of baskets of stocks out into the marketplace at bid-ask spreads that are advantageous to the traders. By essentially anticipating and beating the trends to the marketplace, institutions that implement high-frequency trading can gain favorable returns on trades they make by essence of their bid-ask spread, resulting in significant profits.

The Securities and Exchange Commission (SEC) has no formal definition of HFT, but it  attributes it with certain features listed below:

  1. Use of extraordinarily high speed and sophisticated programs for generating, routing, and executing orders.
  2. Use of co-location services and individual data feeds offered by exchanges and others to minimize network and other latencies.
  3. Very short time-frames for establishing and liquidating positions.
  4. Submission of numerous orders that are cancelled shortly after submission.
  5. Ending the trading day in as close to a flat position as possible (that is, not carrying significant, unhedged positions overnight).

High-frequency trading became commonplace in the markets following the introduction of incentives offered by exchanges for institutions to add liquidity to the markets. By offering small incentives to these market makers, exchanges gain added liquidity, and the institutions that provide the liquidity also see increased profits on every trade they make, on top of their favorable spreads. Although the spreads and incentives amount to a fraction of a cent per transaction, multiplying that by a large number of trades per day amounts to sizable profits for high-frequency traders.

Many see high-frequency trading as unethical and an unfair advantage for large firms against smaller institutions and investors. Stock markets are supposed to be fair and a level playing field, which HFT arguably disrupts since the technology can be used for abusive ultra-short-term strategies. High-frequency traders prey on any imbalance between supply and demand, using arbitrage and speed to their advantage. Their traders are not based on fundamental research about the company or its growth prospects, but on opportunities to strike. Though HFT doesn’t target anyone in particular, it can cause collateral damage to retail investors, as well as institutional investors like mutual funds that buy and sell in bulk. 

  1. What number of shares determines adequate liquidity for a stock?

    Learn how the liquidity of a company's shares is generally affected by bid-ask spread and trading volume of shares bought ... Read Answer >>
  2. What is liquidity management?

    Take a look at the different definitions of liquidity, and find out how investors and businesses attempt to reduce exposure ... Read Answer >>
  3. What's the difference between a capital market and the stock market?

    Learn about the differences between stock market and capital market. Identify several important stock markets and understand ... Read Answer >>
Related Articles
  1. Investing

    High-Frequency Trading Regulations (ETFC)

    Current regulations on high-frequency trading, and possible future ones. How some people think high-frequency trading should be regulated or illegal.
  2. Tech

    High-Frequency Trading Firms Enter Cryptocurrency Markets

    The firms use algorithms to place large orders and book profits. Their entry could make bitcoin prices more volatile.
  3. Trading

    Introduction to Stock Trader Types

    What type of stock trader are you?
  4. Trading

    How IEX is Combating Predatory Types Of High-Frequency Traders

    IEX is an Alternative Trading System (ATS) that seeks to combat predatory trading, particularly high-frequency trading.
  5. Insights

    Hedge Funds and the Law

    Learn how hedge funds have gotten in trouble for illegal insider trading. Read about questionable high-frequency trading (HFT) strategies.
  6. Investing

    IEX vs. Black Pools: Tale of Two Indexes

    Learn the story behind the Investors Exchange Group (IEX) and black pools, which arose from the controversy of high-frequency trading (HFT).
  7. Investing

    Did ETFs Cause The Flash Crash?

    On May 6, 2010, the DJIA plunged 998.5 points in twenty minutes. Find out more about what happened that day.
  8. Personal Finance

    A Day in the Life of a Day Trader

    Day trading has many advantages, and while we often hear about these perks, it's important to realize that day trading is hard work.
  9. Investing

    How To Calculate The Bid-Ask Spread

    It's very important for every investor to learn how to calculate the bid-ask spread and factor this figure when making investment decisions.
  10. Trading

    The Perils Of Program Trading

    The increasing use of program trading makes market glitches inevitable - and sometimes disastrous.
  1. High-Frequency Trading - HFT

    High-frequency trading - HFT is a program trading platform that ...
  2. Dark Pool Liquidity

    Dark pool liquidity is the trading volume created by institutional ...
  3. Specialist Short Sale Ratio

    The specialist short sell ratio compares the short positions ...
  4. Speculation Index

    The speculation index has historically been the ratio of trading ...
  5. Trader

    A trader is an individual who engages in the transfer of financial ...
  6. Market Order

    An order that an investor makes through a broker or brokerage ...
Trading Center