What is High Frequency Trading?

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HFT is the acronym that much of the trading community loves to hate. If statistics are correct, it accounts for the overwhelming majority of market volume every day. It’s also so complex and secretive that a relative few know how it works.

It’s high frequency trading, or HFT. Here’s some of what you should know.

What is HFT?

It depends who you ask but everybody’s definition has one fact in common: Speed. A day trader that holds a stock for minutes is slow compared to a high frequency trading firm (a computer) that measures trades in microseconds, or one millionth of a second.

In its most basic form, a firm in the HFT business has created a computer algorithm that trades on market inefficiencies.  On Sunday, Marketfy sponsored an HFT webinar. During the session, one of the presenters demonstrated how the S&P 500 futures contract reacted to news microseconds faster than the SPDR S&P 500 (NYSE: SPY [FREE Stock Trend Analysis]) ETF.

By taking advantage of that 'speed of light' inefficiency, the trading firm could make (or lose) money—measured in pennies. By running trades like this throughout the market day and collecting rebates that come with being a market maker, HFT with the right computer algorithm can generate large revenue.

'View Marketfy's high frequency trade webinar here.

What is an algorithm?

The use of a special computer program (or algorithm) doesn’t necessary indicate high frequency trading. Nearly all Wall Street participants, including retail investors, place limit and stop orders that will buy or sell only when certain criteria are met.

HFT algorithms also apply certain criteria before making trades but they do it on a faster and more sophisticated scale. The computers that run HFT algorithms aren’t out-of-the-box desktop machines. They’re supercomputers strategically placed to shave off microseconds from the time the order is sent to the time it reaches the exchange.  

The algorithm is constantly being tweaked and changed to maximize performance in changing market conditions. The success of an HFT firm is largely based on the quality of the algorithm.

Do I know the firms involved in HFT?

Goldman Sachs (NYSE: GS) and Morgan Stanley (NYSE: MS) are two of the well-known firms that reportedly operate HFT desks, but many are hedge funds and other firms that operate outside of the public eye.

What if I want to learn more?

This is the first of a multi-part series on high frequency trading. Don’t forget to view or webinar that took place on April 7, 2013. It’s one hour full of in-depth information that every trader should hear. The free webinar can be found on the Markety platform by clicking here.

(c) 2013 Benzinga.com. Benzinga does not provide investment advice. All rights reserved.

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