Currency Battles: Fighting for the lead with high-frequency trading

17, Sep - BLOG

High Frequency Trading HFT involves transmitting orders in financial markets automatically and at a very high speed, without human intervention, using complex computer programmes known as algorithms. This strategy is implemented within a very short holding period, allowing traders to react quickly to market changes. HFT plays a key role in today's financial markets by increasing liquidity and trading efficiency.

The technology and profitability of high frequency trading

These programs constantly analyse electronic order books on stock exchanges to anticipate and take advantage of market micro-movements. If a favourable opportunity is identified, THF allows you to take a position in the same order book to take advantage of the emerging price trend. This strategy is implemented over a very short holding period. In practice, trades are executed in a very short period of time, on the order of microseconds, which explains the efficiency of these new trading methods in placing orders among the orders of other market participants.

IT infrastructure plays a key role in explaining this efficiency. For this reason, the development of HFT order movement programmes requires powerful machines, usually installed geographically as close as possible to the servers of the major stock exchanges, in order to increase the speed at which instructions are transmitted to the market. In addition, the number of financial players utilising these trading methods is very small given the expensive technological investments required in this area.

The objectives of high-frequency trading are aimed at optimising profits and increasing the efficiency of transactions in the financial markets:

• Maximising the number of trades: High-frequency traders always aim to increase the number of trades so that the total profits from many small transactions add up to a more significant amount;
• Increasing market liquidity: One of the goals is to increase market liquidity, which facilitates quick entry and exit of positions without significant price changes.
• Capitalising on market micro-movements: HFT algorithms aim to profit from any, even the smallest price fluctuations by executing trades a fraction of a second before other market participants;
• Reduced order execution costs: High-frequency trading minimises costs through fast execution and optimised trade timing;

This helps to understand why HTF has grown in importance in recent years: according to the Tabb Group, between 2007 and 2011, the daily trading volume on European stock markets increased from 9% to 40%. By 2023, nearly two-thirds of stock market trades will be executed by high-frequency traders. More recently, high-frequency trading has emerged in cryptocurrency markets such as bitcoin and ether.

Risks and controversy surrounding high-frequency trading

Support for high-frequency trading is far from unanimous, especially among financial market regulators and supervisors such as the Authority for the Financial Markets (AMF). According to its proponents, HFT enhances market liquidity, promoting market efficiency for the benefit of all investors. Firstly, possible computer glitches or errors can destabilise the market: this is known as a flash crash. According to critics, HFT carries two significant risks.

Flash crashes are sudden collapses in stock prices caused by the frantic performance of HFT algorithms, although these mechanisms are not always well understood. One of the most famous flash crashes occurred on 6 May 2010 in the US. The Dow Jones index lost 9.2% of its value in 10 minutes. The second risk associated with the Dow Jones is price manipulation.

The technological tools used in HFT allow stock prices to be analysed at a speed unavailable to other market participants, creating an asymmetry of information between different stakeholders. High-frequency trading will create a kind of ‘unfair competition’ that will drive other participants out of the market. The latter may think that the best opportunities are slipping away from them anyway, having been exploited by faster players than them before they can access them. In addition, there is a big difference between the size of orders initiated by HFT and the orders actually executed.

Regulation of high-frequency trading

In order to mitigate the risks associated with high-frequency trading strategies, regulators in developed countries have introduced measures to regulate the practice. These include enhanced data analysis systems, temporary trading halts, stricter requirements on traders' strategies and the introduction of minimum trade execution (and cancellation) times. These measures are aimed at ensuring that financial markets function in a more stable and fair manner.

High Frequency Trading: Conclusion

High Frequency Trading (HFT) plays a key role in today's financial markets by increasing liquidity and trading efficiency. However, it carries significant risks, including the potential for flash crashes and price manipulation, raising serious concerns among regulators. To mitigate these risks, stringent regulatory measures have been introduced to ensure that markets operate in a more stable and fair manner. In the future, the further development of HFT will depend on the ability of markets to adapt to these challenges and the effectiveness of the regulatory measures taken.