What is High Frequency Trading?

Submitted by Share Trading on 5 November, 2010 - 08:53

What is High Frequency Trading?

High-frequency trading is the execution of computerized trading strategies characterized by extremely short position-holding periods. In high-frequency trading, programs running on high-speed computers analyze market data, using algorithms to utilize trading opportunities that may open up for only a fraction of a second to several hours. High-frequency trading, often abbreviated HFT, uses quantitative investment computer programs to hold short-term positions in equities, options, futures, ETFs, currencies, and all other financial instruments that possess electronic trading capability. High frequency traders compete on a basis of speed with other high frequency traders, not long term investors (who typically look for opportunities over a period of weeks, months, or years), and compete with each other for very small, and very consistent profits. As a result, high-frequency trading has been shown to have a potential Sharpe ratio thousands of times higher than the traditional buy-and-hold strategies. (The Sharpe ratio or Sharpe index or Sharpe measure or reward-to-variability ratio is a measure of the excess return (or Risk Premium) per unit of risk in an investment asset or a trading strategy)

By 2010, High Frequency Trading is accounting for over 70% of equity trades taking place in the US, and is rapidly growing in popularity in Europe and Asia. Aiming to capture just a fraction of a penny per share or currency unit on every trade, high-frequency traders move in and out of such short-term positions several times each day. Fractions of a penny accumulate fast to produce significantly positive results at the end of every day. High-frequency trading has become more popular recently thanks to technological innovation, and growing awareness of its profitability. High frequency trading firms do not employ significant leverage, do not accumulate positions, and typically liquidate their entire portfolios on a daily basis.

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