High-Frequency Trading (HFT), or High-Frequency Trading (HFT) in English, is a method of submitting ultra-fast stock market orders (in the order of milliseconds, microseconds, or even nanoseconds if only part of the process is taken into account) that is fully automated, with positions, both buy and sell, being taken by somewhat sophisticated algorithms.
This practice goes hand in hand with the automation and gradual modernization of financial markets, with order books gradually being automated and moved to state-of-the-art data centers such as Basildon and Slough in the United Kingdom, or Mahwah, Aurora, and Carteret in the United States. Furthermore, this practice stems from a process of deregulation and liberalization of financial markets that began in the late 1980s with the privatization of national stock exchanges, followed by the emergence of alternative exchanges that competed with so-called « traditional » exchanges.
High-frequency trading (the practice) gives its name to the high-frequency trader (the institution), a firm or entity within a firm (a desk) built around a team of telecommunications engineers, quantitative analysts, and other programmers in C, C++, Java, Batch, Python, Perl, Bash, RoR, Shell, or other languages, using their own capital (rather than that of their clients) and seeking to minimize their latency, i.e., the time between placing an order and executing it, through the use of colocation, in other words, the use of a server located directly at the heart of the stock exchange in order to increase responsiveness, and/or through privileged access to information (subscription to data feeds). However, high-frequency traders can also be isolated proprietary traders with the necessary knowledge to engage in this activity.
High-frequency traders (HFTs) are thus able to intervene surgically in the order books of various stock exchanges around the world and take advantage of extremely short-term opportunities, which are generally imperceptible to a human trader, allowing them to pocket very small gains repeatedly (every little helps). Their positions in the market are therefore short-lived, due to an extremely short investment horizon,and are closed or hedged at the end of the trading day to avoid any price shifts overnight. Five strategies are mainly used by HFTs: (1) high-frequency market making, (2) high-frequency arbitrage, (3) high-frequency directional trading, (4) high-frequency structural trading, and (5) high-frequency price manipulation (the latter practice being obviously illegal).
Although high-frequency traders represent only 2% of participants, their transactions account for a large share of the volume on the various stock exchange platforms, around 60% of the volume on the US stock market, 40% of the volume on the European stock market, and around 30% of the volume on the Asian stock market.
Finally, empirical research tends to show that high-frequency trading is rather beneficial, at least under so-called « normal » market conditions: lower transaction costs for end investors, market defragmentation, increased liquidity, and greater market efficiency. However , certain risks should not be overlooked , particularly in so-called « abnormal » market conditions (volatile markets), such as liquidity risk (flash crashes), operational or technological risk (bugs), counterparty risk (bankruptcy of low-capitalized THF firms), price manipulation risk, and systemic risk (contagion).
Further reading:
The speed of reaction of financial markets in the modern era (Floris Laly, L’AGEFI)
