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All You Need to Know About High Frequency Trading

30 Jan 2020

High Frequency Trading has been a buzz word in the trading fraternity for quite some time now. There has been a monumental growth in high-frequency trading in markets around the world. High-frequency trading has been able to help not just the markets and domestic and foreign companies as well. On the contrary there have been some negative and controversial aspects to HFT as well. This blog addresses high-frequency trading strategies, systems, and controversies, and then analyzes current and potential laws and regulations and their impacts on the marketplace.

High-frequency trading algorithms are focused primarily on speed, mostly because the majority of high-frequency traders use arbitrage strategies to generate their earnings. These arbitrage algorithms monitor prices of the same assets on different markets, where one is a benchmark for another. When there are some movements in price on a benchmark market, High-frequency trading executes orders on another market towards the same direction to exploit divergence.

The Pros

Obviously, in order to succeed in arbitrage, they must be faster than others which is the reason for ever-increasing speed. There are many benefits that HFTs offer to institutional and individual traders. Here are some benefits of trading in through this mode.

1. More Liquidity: High-frequency trading’s' share of market orders is significant and, therefore, it may be stated that high-frequency trading algorithms add a big share of liquidity to the markets mostly by passive market-making strategies. Market-making strategies minimize the spread between purchases and sell prices and also increase the depth of the secondary market. These factors are very important for potential investors because liquidity makes them confident with trading in big volumes. Additionally, big volumes cause transaction costs to reduce which is beneficial for all market participants.

2. Fair price valuation and volatility: High-frequency trading require high volatility to earn returns. From this perspective, they simply reduce the deviation of an asset from its medium. This detail is very attractive for long-term investors because for them it lessens the risk of acquiring an asset at a bad price. The efficiency of the markets grows with faster valuation and fairer prices caused by High-frequency tradings. It may be said that irrational investors (including those with high leverage) are penalized by High-frequency trading.

High-frequency trading is not directly involved in the process of initial public offerings which are used by companies to accumulate new share capital.

3. New techniques, new opportunities: A wide range of fundamentally different strategies came to the markets with High-frequency trading algorithms. Some people get that such variety is giving flexibility and sustainability of the markets in general. High-frequency tradings can provide real-time response to market changes.

The Cons

On the other hand, there are many people who disagree with the positive image of High-frequency tracings. In their view, High-frequency trading cause uncertainty and can bring a catastrophe to the whole financial institution system.

• Market manipulations and fake liquidity:  Sophisticated infrastructure of stock exchange gives a wide range of strategies for earnings. There is a practice of front-running big trading orders from institutional investors. High-frequency trading can track big institutional orders. Then they generally try to absorb liquidity. The final step is to close High-frequency trading s' positions counter to big investors. The costs for institutional investors at the end are much higher.

Another plan related to misleading investors is called spoofing. When a high-frequency trader owns some shares, it can try to grow the price by placing purchase orders. The true intention of this operation is to entice other buyers in order to sell them initially owned shares at a higher price at the same time canceling its own purchase orders. Both of these strategies reason unfair pricing for other market participants and can be classified as market manipulations.

• Maintenance costs: High-frequency trading s' algorithms require a large number of processing powers and all exchanges have to constantly update their equipment, cables, and structure of working in order to be able to handle this increasing flow of High-frequency trading s' orders. It can expend costs for all market participants.

Many changes in the equity markets and their trading procedures have occurred. The most confirm change is that trading has become incredibly speedy. With the increase in speed there is also increased risk in the market. So, it is recommended to get your risk profile analysis before you enter. The High Frequency Trading Algorithm is a perfect example of the transformation of financial markets.

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As On 30th April, 2020
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