Have you ever wondered what comes to your mind first when you hear the word “trading”? For the vast majority of people, the answer to this question would probably be something like “men, suits, screaming and looking at fast-moving charts on a big screen on Wall Street.” However, the reality turns out to be completely different.

At the outset, it should be mentioned that today’s trade is very diverse. The group of traders includes such a wide spectrum of people as a young student who uses a trading application, a middle-aged businesswoman researching ETFs in which she is interested in investing her life savings, or large corporations or hede funds that use advanced algorithms that process thousands of transactions per second to make the best possible choice. The latter type of trading is the topic of the following article. This trading model is called high-frequency trading or HFT.

What is High Frequency Trading (HFT)?

High-frequency trading or HFT is a highly sophisticated trading method that uses complex computer programs to execute a huge number of orders per second. Nowadays, this also includes the use of powerful AI algorithms that constantly analyze the market to then find price discrepancies in bid-ask spreads. All this is done for one purpose, specifically to identify the best buying/selling opportunities. It is worth noting that this method consumes a lot of computing power and this is one of the reasons why HFT is not available to every trader.

Understanding High Frequency Trading (HFT)

High-frequency financial operations should be viewed as thousands or even millions of regular trading sessions performed in just a few seconds, regardless of the investor’s investment volume. After their creation, HFT algorithms can independently open and close thousands of different transactions per second without any human intervention, which makes them an extremely effective tool for multiplying capital.

Traders who use HFT use advanced code to exploit financial parameters such as short timeframes, small differences in bid-ask spreads, but also market trends. To bring the best results, HFT must be constantly updated and kept in a state of permanent optimization (which often involves significant financial outlays). As a result, it is a very greedy mechanism that uses all kinds of resources in its operation, starting with huge computing power.

Nothing prevents individual investors from running high-frequency trading algorithms created by themselves. However, it must not be forgotten that a significant barrier on this path is that it requires an above-average understanding of both programming and the operation of financial markets, as well as adequate resources to run the above-mentioned algorithms. In addition, HFT is most often associated with an exceptionally high total volume of processed financial operations, which, consequently, is also very demanding in terms of computer hardware.

The effect of the above-mentioned requirements related to the creation and use of HFT is that in practice this trading model is used on a large scale only by institutional investors. A significant number of small traders see this tool as a form of exercise or a time-saving way to earn a few dollars.

How does high frequency trading work?

The purpose of using HFT is short-term profits, which would be impossible for a human being in principle. This is primarily because these algorithms process thousands of calculations per second to consequently determine whether an asset is undervalued or overvalued. HFT algorithms are also great at detecting triggers that would certainly be completely invisible to a single trader.

The mechanics behind high-frequency trading are constantly trying to take advantage of and then profit from any discrepancies they can detect in any bid-ask spread. Profits from these transactions are usually small. However, this is not about the profit that HFT generates on a single transaction. All the math comes down to the cumulative profit an institutional investor makes using this tool. Ultimately, an AI-based system can perform thousands of transactions per second.

Taking into account the objective fact that HFT is so dependent on capturing a favorable moment to open and close trades, it must be run on very efficient and modern hardware. This is one of the main reasons why this solution is not widely available to retail traders. Additionally, traders using the operation of high-frequency trading must have a thorough understanding of the market they are trading in and must be ready for any unforeseen problems and difficulties that may arise.

Cryptocurrency high-frequency trading

High-frequency trading is increasingly used in the cryptocurrency sector. It works in this area as reliably as in the case of more classic assets, such as the price of shares or commodities. Cryptocurrencies and the significant price volatility associated with them are ideal for institutional investors who have the opportunity to take advantage of above-average bid-ask spreads.

The digital currency sector makes arbitrage trading really easy, and this is one of the cornerstones of the trading strategies that are used in high-frequency trading. After all, after reading this text, you already know that the HFT operating model is based on looking for differences in the price of assets, and it does not matter whether the price differences occur between cryptocurrencies such as Bitcoin or Ethereum or between other classes of investment resources such as stocks, bonds, fiat currencies or commodities.