It would probably be an exaggeration to say that we are now witnessing a high-frequency trading boom. What is certain though is that this type of investing has proved to be pretty lucrative. Research shows that its revenue for the past five years accounts for $5.7 bn. The same research likewise reveals that the competition in this field is mainly centered on tech. In effect, access to the latest and the most fitting tech is now the major precondition for success in HTF. And this is where things get interesting.
What Is High-Frequency Trading (HFT)?
Let’s start with the basics. High-frequency trading is a type of algorithmic trading. Sounds complicated but the latter is just trading that strives to remove emotions from the process and make it all algorithm-based. It uses powerful computers to transact a large number of orders. And the key point here is that all these transactions are completed within milliseconds.
Now, who are the traders here? Typically, they are large financial institutions or hedge funds. But in theory, they can be anyone with enough resources and technical expertise to develop and maintain sophisticated HFT systems.
The main goal of all this is profit, of course. And profit, in this case, is underpinned by very small price discrepancies. When you execute trades quickly and in large volumes, you can capitalize on these tiny differences before other market participants notice them.
5 Technologies Essential For HFT
As we’ve already mentioned, HTF is highly reliant on tech. The latter is, in fact, the central factor that determines traders’ competitive advantage. But what kind of tech is implied exactly? Here are five examples.
Low-Latency Networks
HFT is mainly about speed. Low-latency networks are necessary to ensure that data travels from the trading firm’s servers to the exchange and back as quickly as possible. The time it takes to execute a trade is thus minimal.
HFT firms invest heavily in low-latency infrastructure. It’s the primary concern for those who want to succeed in this field. Such an infrastructure can include
- direct market access (DMA)
- colocation services
- and even custom-built fiber-optic networks.
In a word, it uses anything that can potentially minimize transmission delays
High-Performance Computing (HPC)
Another must-have is HPC. It provides the computational power that is required to process vast amounts of data in real time. HFT firms use powerful servers and supercomputers to run their trading algorithms. Otherwise, they wouldn’t be able to handle the massive computational load.
Field-Programmable Gate Arrays (FPGAs) are also used to further accelerate processing speeds. FPGA design services are in high demand among traders as they provide access to custom hardware configurations optimized for specific trading algorithms.
Overall, you can hardly find an HFT firm that doesn’t use high-performance computing as the latter is crucial for maintaining speed and efficiency. Without it, a firm would be unable to execute complex calculations quickly and analyze multiple data streams simultaneously.
From this standpoint, it’s not HPC as such that gives a competitive advantage (after all, everyone’s using it) but rather FPGA. The latter provides an additional performance boost and reduces latency even further.
Advanced Algorithms
HFT relies on sophisticated algorithms to make split-second trading decisions. These algorithms
- analyze market data
- identify trading opportunities
- execute orders.
Needless to say, they do all this at lightning speed. They are designed to detect patterns and signals that human traders miss.
Again, all (or almost all) traders use advanced algorithms. They are the brains behind HFT operations. They allow firms to automate the trading process and maintain a certain level of consistency and precision.
Here, it’s the competition between algorithms, not people with their skills or knowledge. The more advanced the algorithm, the better it can adapt to changing market conditions.
Real-Time Data Feeds
Access to real-time data feeds is vital for HFT. These feeds provide up-to-the-millisecond information on market prices, order book depth, and trading volume. HFT systems rely on this data because the task is to make the most accurate trading decisions possible.
Can HTF forms operate without real-time data? Perhaps they can but they would be doing it blind. They wouldn’t be able to react instantly to market movements because they wouldn’t learn about them on time.
Risk Management Systems
You will probably agree that risk management systems are essential in all types of investing. Their role is to monitor trading activity and market conditions and identify anomalies. These systems can halt trading if something unexpected market happens. So they actually protect firms from significant losses.
How Profitable Is HFT?
The question of whether or not HFT is profitable is a difficult one. First and foremost, this type of trading is about high margins on small transactions. That is, it relies on a large number of transactions at high speed to profit from minuscule price discrepancies.
Yes, the profit on each individual trade might be tiny. But the cumulative effect can be substantial. For example, an HFT firm might make a fraction of a cent on each trade, but by executing millions of trades, those small profits add up. Does it sound profitable? Perhaps.
Then, HFT firms often act as market makers because they provide liquidity to the markets. That is, when you buy and sell securities, you narrow the bid-ask spread and earn profits from the difference. From market making alone, such firms can earn millions of dollars.
And finally, we’ve mentioned this many times already but it’s indeed important. The profitability of HFT is heavily dependent on the speed and sophistication of the technology used. As a result, firms invest millions in low-latency infrastructure, advanced algorithms, and high-performance computing. There are no alternatives to this if you want to gain a competitive edge. Those with the fastest and most reliable systems can capitalize on fleeting opportunities. But what about those with a little bit slower tech? As you may guess, they lose. And this means that their million-dollar investments don’t pay back.
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In the long run, it’s up to you to decide whether or not HFT is worth it. The key thing to keep in mind about it is that tech rules here. Therefore, it is indeed a good idea to first consult specialized development services that will explain to you in detail how to build a strong system for HFT.