Trading on financial markets is a vast and profitable industry. However, it can be difficult to fully understand the intricacies of trading with only a casual interest in finance. Luckily for those people, public figures and websites provide an outline of high-frequency trading (HFT) and its role in the market.
High-frequency trading is also becoming increasingly common in London’s financial centre. The United Kingdom has made HFT a priority, hoping to attract significant foreign investors by providing them with unique opportunities unavailable to them elsewhere. While the LSE does not reveal statistics about its HFT clients, they are growing rapidly. And because outside parties fuel this expansion, these figures are likely to continue to grow exponentially over the next few years as well.
What is High-frequency trading(HFT)?
High-frequency trading is characterised by holding positions for fractions of seconds or minutes, not days or weeks, as with traditional ‘long term’ investing. To do this requires colossal computing power to analyse massive data flows and execute orders based on these analyses in under a second. HFT allows traders to jump ahead of large orders submitted by investors, executing their trades before the big block gets into the market and pushing prices away from where they would otherwise be, allowing small profits to solidify into large ones.
The pros and cons of HFT
Many people worry about the volatility caused by HFTs, given that the majority of trades on modern markets involve computer algorithms working at lightning speeds. However, it could be argued that without HFTs, markets would become inefficient and lose liquidity to the extent that prices wouldn’t reflect the actual value of assets.
HFT uses sophisticated technology to send orders to financial centres at high speeds. This practice has become increasingly common in recent years, but its existence has not gone without criticism. Opponents say these trades are ‘unfair’ because they take advantage of large institutional investors who do not have the same information as HFT companies. On the other hand, supporters argue HFTs help institutional traders by providing liquidity for their trades and narrowing spreads.
HFT is controversial as it takes advantage of other market participants and can exacerbate market volatility, as seen in May 2010 when HFT related issues contributed to the ‘flash crash’ where US markets plummeted 10%. However, HFT has also been credited with making markets more efficient by increasing competition and lowering spreads (the difference between the bid and offer prices of a stock).
The most common HFT strategies
The most common types of HFT strategies are statistical arbitrage and market-making.
Statistical arbitrage
Statistical arbitrage refers to a strategy where large amounts of historical data are analysed to identify market mispricing – i.e. where current sugar prices do not reflect how much sugar was traded yesterday or last week – and exploited by purchasing assets when they are cheap and selling them when they are expensive.
Market making
Market making uses similar technology to provide liquidity on exchanges with inadequate numbers of buyers or sellers by trading stocks back and forth between clients, taking tiny profits on each trade.
The future of HFT in London
The future of high-frequency trading strategies in London remains uncertain, but one thing that is certain is that there will remain space for growth. As long as capital continues to pour into this industry, HFT companies will grow. London’s financial centre is well aware of this and continues to promote itself as a major destination for these types of investments.
Bottom Line
Trading is a game of speed. A trader who can make decisions faster than their competitors has an advantage that can be captured by high-frequency trading strategies. Beginner traders should use a reputable online broker from Saxo Bank before investing in listed options.
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