High Frequency Trading in the Stock Market, How it Works
High Frequency Trading (HFT) is when a trader or institutions utilizes technology and powerful computers to automate trading and execute large orders at very high speeds through the use of algorithms.
Their super computers are able to scan the market in secs looking for ideal trading scenarios which gives them an advantage over retail traders who do not have the resources or capital to trade in this manner.
Since speed is Key to getting the best execution price possible, super computers are making their owners more money than traders with slower computers.
Traders who utilize HFT build algorithms that analyze stocks and price patterns much more quickly than any person can, giving them an edge in spotting new market trends.
Usually High Frequency Traders are not looking to make 1 big trade but rather make a lots of small ones sometimes only looking to scalp a couple of cents between the bid and ask prices, which does not sound like a lot, but when doing millions of trades a day it adds up to a lots of money.
HFT became popular after exchanges started to offer incentives to provide liquidity in the markets, which would then earn them fractions of a penny per share for providing the liquidity, known as a rebate.
So, if you are placing orders to buy at the bid or lower and are executed on the trade, you are providing liquidity in the markets where if you placed a market order to buy you would be taking liquidity out of the market and would not receive the rebate.
HFT has been both a good and bad thing because now there is plenty of liquidity in the markets, but it has been viewed as an unfair advantage for large firms who have the resources to take action quickly.
Small retail traders can be subject to large market moves for no reason because a computer had a glitch, which is what happened in the May 2010 when the DJIA dropped over a 1,000 points in 20 mins.
There is a large benefit that many of not most people do not understand is that before High Frequency Trading existed, the cost of trading stocks was much higher and spreads were larger.
HFT’s have provided big liquidity in the markets and made it cheaper for retail traders to place trades and participate in the markets.
Remember, it is your money, your responsibility, and always take what the market gives.