High-Frequency Trading (HFT) — The World of Microseconds
The moment you press the 'buy' button, some computer may already have finished thousands of trades. The world of high-frequency trading, where trades happen in the blink of an eye.
What high-frequency trading is
High-Frequency Trading (HFT) is a form of algorithmic trading that uses ultra-fast lines and computers to place enormous numbers of orders in units of milliseconds (a thousandth of a second) and microseconds (a millionth of a second).
The core is a speed race to 'react before others' — by placing servers physically closer to the exchange (colocation) or securing faster data lines.
The profit from a single trade is tiny, but by repeating it countless times per second, profits accumulate.
How big is it in the market
HFT accounts for a substantial portion of the U.S. stock market.
Estimates differ by source, but recently roughly around half of U.S. stock trading volume is classified as HFT. Around 2009 it was estimated as high as the 60% range, and many sources say it later fell to around 50%.
However, this figure is an estimate that varies greatly by definition and methodology, so it is safer to understand it as 'a participant that takes a large share of trading' rather than 'exactly what percentage.'
What it means for individual investors
Assessments surrounding HFT are split.
On the positive side, there is the argument that through market making it narrows the bid-ask spread and supplies liquidity, lowering trading costs.
On the negative side, critics point to using a speed edge to cut in front of other orders, and to the risk of amplifying sudden crashes. The 2010 Flash Crash is cited as the representative case.
The important point for long-term, diversified investors is this. HFT's speed race is a world of milliseconds, and the success or failure of investing that steadily buys and holds over several years is almost entirely unrelated to that speed contest.
The HFT share figures are estimates that vary widely by definition and source (generally around 50%, once in the 60% range). This article does not recommend day trading or the speed race, and emphasizes that for long-term investors, a per-second speed contest is not the key to success or failure.
Frequently Asked Questions
Q. Is HFT a disadvantage to individual investors?
It is hard to say definitively. The positive view that it supplies liquidity and narrows spreads coexists with the criticism that its speed edge is unfair. That said, for long-term, diversified investors the impact of a millisecond-level race is relatively small.
Q. Does HFT also cause sudden market crashes?
When algorithms react in a chain, volatility can be amplified in a short time. The 2010 Flash Crash is an example — an event where the market plunged within minutes and then substantially recovered.
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