High-Frequency Trading (HFT)

High-frequency trading (HFT) strategies use sophisticated algorithms to execute trades at lightning-fast speeds, often measured in microseconds. This guide explains how high-frequency trading software works, from the pros and cons to UK regulations and risk management considerations. Our team have also listed the best high-frequency trading brokers and platforms:

High-Frequency Trading Explained

High-frequency trading programs execute a large volume of trades ultra-fast, from hundreds or even thousands of trades per second. These algorithms are typically designed using open source programming languages like Python or Java and are executed on platforms that are optimised for high-frequency trading.

This style of automated trading has become increasingly popular in recent years, particularly following the implementation of MiFID II regulations, which placed greater emphasis on the use of electronic trading and data analytics in financial markets. It is now estimated that 50% of US stock trading volumes are driven by high-frequency trading systems.

How High-Frequency Trading Works

High-frequency trading firms use various strategies to identify profitable opportunities, such as statistical arbitrage and market making. These often rely on quantitative analysis techniques, plus machine and deep learning algorithms that can identify patterns and trends in market data that are difficult or impossible for human traders to detect.

High-frequency trading typically relies on specialised hardware and software designed to reduce latency. Reducing latency, or the delay between receiving market data and executing a trade, is critical to the success of high-frequency trading. Even small delays can result in missed opportunities or unfavourable execution quotes. As such, high-frequency trading platforms invest heavily in technology and infrastructure, including high-speed data networks and customised servers to optimise transaction speeds.

High-frequency trading firms are also exploring emerging technologies such as quantum computing. These powerful machines are capable of processing vast amounts of data and performing complex calculations at speeds that are orders of magnitude faster than traditional computers.

Importantly, the main characteristics of a high-frequency trading setup are speed and volume. Other key features include:

• Automation: High-frequency trading strategies are automated, with complex algorithms entering and exiting the market sometimes thousands of times a second.
• Data analysis: High-frequency trading firms use advanced data analysis techniques to identify market inefficiencies and generate signals. This can involve analysing vast amounts of historical data, as well as real-time market data.
• Low margins: High-frequency trading strategies typically operate on low margins, with profits generated by small price movements across a large volume of trades.
• Technology-driven: This method of trading is highly dependent on advanced technology, including low-latency trading infrastructure and powerful computing systems.

For Retail Traders

Technically, anyone can participate in high-frequency trading, but in reality, it is mostly limited to institutional investors and professional traders due to the high costs and advanced technology required.

Retail investors may not have the financial resources or access to the necessary infrastructure to engage in high-frequency trading. Additionally, the competition in the high-frequency trading market is intense, and success often depends on having access to proprietary data and market information, which may not be available to retail traders.

But whilst high-frequency trading is usually beyond the reach of small investors trading from home, there are some software options available for individuals.

One strategy is to use algorithmic trading software that provides signals based on set criteria or technical indicators. These signals can be used to automate trades using bots and execute orders quickly and efficiently.

Another option is to invest your money in funds or other financial products that deploy high-frequency trading strategies. However, these trading vehicles often come with high fees and large minimum investment requirements.

History Of High-Frequency Trading

High-frequency trading first emerged in the UK in the early 2000s, when firms began using computer algorithms to make fast trades.

In 2010, the “Flash Crash” occurred, during which the US stock market experienced a rapid and severe drop in prices. Many attributed this crash to high-frequency trading firms. Prices picked up again shortly after, but this event led to increased scrutiny of high-frequency trading systems around the world.

In recent years, the UK has seen the development of new trading venues and platforms, such as the London Stock Exchange’s Turquoise platform, which caters to the needs of high-frequency trading platforms and other high-volume traders.

High-frequency trading remains a significant force in the UK financial markets, with many firms using advanced algorithms to process vast amounts of market data from large databases, all in real time.

However, the use of high-frequency trading in the UK remains controversial, with some arguing that it can exacerbate market volatility and create an unfair leg-up for certain market participants, putting retail traders at a disadvantage as they lose out on the opportunity to capitalise on small price movements.

Regulations

The FCA has not made high-frequency trading illegal, but like other regulators, they have implemented rules to reduce the concerns surrounding market manipulation and other critiques. For example, its handbook sets out rules around market abuse, including manipulating prices or engaging in insider trading.

Additionally, MiFID II, first proposed in 2011 following the 2010 Flash Crash, was an update to the original 2007 MiFID rules, targeting high frequency trading. Under the new MiFID II definition, firms are required to provide detailed information about their trading activities, including the use of algorithms and high-frequency trading programs. This information must be reported to regulators in real-time, enabling them to monitor market activity and identify potential issues.

Pros Of High-Frequency Trading

• Market Liquidity: High-frequency trading firms provide liquidity and facilitate price discovery by acting as market makers. This is one of the biggest benefits of high frequency trading as market makers can help to reduce bid-ask spreads and allows traders to enter and exit positions more easily.
• Access To Dark Pools: HFT firms participate in dark pools which are private trading venues that are typically only accessible to institutional investors and large financial firms. They allow buyers and sellers to trade large blocks of shares anonymously, without disclosing the identity or size of their orders to the broader market. This can help to reduce market impact and improve execution quality.
• Market Stability: High-frequency trading can improve market stability by providing liquidity during periods of volatility or uncertainty. This can benefit retail traders by reducing the likelihood of market disruptions or flash crashes. Although some blame the Flash Crash of 2010 on high-frequency trading programs, this has since been debunked by the CTFC in 2014.
• ETFs: High-frequency trading can also benefit retail traders who invest in ETFs, as firms can help to ensure that prices remain closely aligned with the underlying assets through arbitrage. This can help to reduce tracking errors and improve overall returns.

Cons Of High-Frequency Trading

• Unfair Advantages: To participate in high-frequency trading, you must have access to fast and sophisticated trading technology, which is typically only accessible to large firms. This can create unfair advantages and allow them to extract profits at the expense of slower and smaller market participants.
• Complexity: High-frequency trading algorithms are complex and difficult to understand, making it harder for regulators and market participants to monitor and control the activities of such companies.
• Risk of System Failures: High-frequency trading firms rely heavily on technology, meaning they can be vulnerable to system failures and cyber attacks, causing significant disruption.

How To Compare Brokers That Offer High-Frequency Trading

• Network tools and infrastructure: Look for brokers that offer low latency connections to the financial markets, as well as high-speed servers and advanced network tools.
• Fees: High-frequency trading strategies involve executing a large volume of trades, so transaction costs can have a significant impact on profitability. Look for HFT brokers that offer competitive pricing with low to zero commissions, tight bid-ask spreads, and minimal slippage.
• Limit order books and quote data: HFT traders rely on real-time order book and quote data to execute trades quickly and efficiently. Brokers with access to real-time order books and customisable data flows will rank highly.
• Automation: The best high-frequency trading brokers offer automated apps, trading tools, robots and integration functionality to design, test and deploy HFT strategies. Many algorithms within the industry are designed with reliable programming languages such as Python or Java.
• Trading instruments: Consider the range of trading instruments available, including options, futures, forex and even cryptos such as Bitcoin. Note, some high-frequency trading brokers specialise in certain markets or asset classes.
• Rules: Due to the risks involved in high-frequency trading, some brokers may have certain criteria. For example, LMAX Exchange is a UK-based broker that specialises in forex trading. They require traders who want to engage in high-frequency trading to have at least £25,000 in capital and to demonstrate their knowledge and experience in HFT systems. They also require traders to sign a declaration of compliance with their high-frequency trading rules and regulations.
• Customer service: With high-frequency trading, every nanosecond counts, so access to a responsive customer support team 24/5 is important.
• UK regulation: The best high-frequency trading brokers for British traders are regulated by the Financial Conduct Authority. An FCA license adds credibility to a brand while ensuring what safeguarding initiatives should be in place to comply with law, such as segregated accounts and negative balance protection (for retail traders).

Specialist HFT Platforms

Specialist platforms for high-frequency trading include NYSE Arca, NASDAQ OMX, and CME Globex. CME Globex is particularly popular amongst high-frequency trading firms and is accessible to retail traders through specific brokers.

• CME Globex allows traders to choose from a range of advanced order types that are specifically designed for high-frequency trading, including iceberg orders, stop orders, and market orders.
• CME Globex is designed to provide fast and reliable access to global futures and options markets, with an average round-trip latency of less than 40 microseconds. This makes it a popular choice among high-frequency trading platforms looking to execute trades quickly and efficiently.
• CME Globex offers direct market access to its exchange, allowing high-frequency traders to bypass traditional brokers and connect directly to the exchange’s matching engine. This can help to reduce latency and improve execution times.
• CME Globex also offers co-location services, which allow high-frequency trading organisations to place their servers near the exchange’s matching engine. This can help to reduce network latency and improve execution times.

High-Frequency Trading Firms In The UK

In the UK, multiple firms implement high-frequency trading strategies to maximise profits. Some of the largest companies with offices in London, as well as New York, Amsterdam and Hong Kong are:

• Tower Research Capital: A global quantitative trading firm that uses HFT strategies to trade across a range of asset classes, including equities, forex, and futures. TRC has offices in London and other global financial centres.
• Optiver: A proprietary trading firm that also uses high-frequency trading systems. The company has been active in the UK since 2010 and has a significant presence in London.
• Jane Street: Active since 2013, Jane Street is a quantitative trading firm that uses advanced mathematical models and high-frequency trading strategies to trade various financial instruments, including stocks and forex.

Bottom Line On High-Frequency Trading

High-frequency trading systems are used by experienced traders and institutional investors such as hedge funds. But with the emergence of new technologies like quantum computing, high-frequency trading programs are increasingly becoming available to retail traders. To get started, see our list of the best high-frequency trading brokers.

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