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High-Frequency Trading

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Introduction

The fundamental objective of the essay is to evaluate the challenges of high-frequency

trading along with real-world examples. High-frequency trading (HFT) is referred to as the

technique of trading that utilizes influential computer programs to execute a large number of

orders in a fraction of a second.

High-frequency trading challenges

High-frequency trading is primarily carried out by powerful computers that utilize

composite algorithms to scrutinize numerous markets and implement orders based on the market

situation. Besides this, HFT is a mechanized trading platform employed by substantial

institutional investors, hedge funds, and investment banks. As per the perspective of investors,

HFT can be defined as the usage of powerful computers to execute a large number of orders at

tremendously high speed (Baldauf & Mollner, 2020).

It is recognized that HFT is not only beneficial to traders but also the overall market. It is

analyzed that HFT develops high liquidity and, as a consequence, ease the effect of market

fragmentation. In addition, HFT helps in the discovery of price and process of price formation

because it is based on a large number of orders. It is described by high order to trade ratios, high

turnover rates, and high speeds that leverage electronic trading tools and high-frequency

financial data.

Moreover, there are different challenges that occurred in the growth of HFT. High costs

of entry are one of the obstacles to the growth of HFT, which involve the development of

algorithms, creating an infrastructure that needs frequent high-cost upgrades, setting up high-

speed trade execution platforms, and subscription charges towards data collection (Kirilenko,
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Kyle, Samadi & Tuzun, 2017). Declining potential profit, strict regulations, and high operational

costs are considered as significant challenges in the development of HFT.

It is analyzed that HFT delivers a reduction in opportunities in the future for traders in

established markets like the US. It is argued that algorithms can be programmed to transfer

hundreds of fake orders and cancel in a second. Besides this, high-frequency traders seem to be

profitable because it could make an average profit of $1.92 for each contract traded with large

institutional investors.

HFT is the execution of complex and algorithm-based occupations by prevailing

computers. The primary purpose of HFT is to take benefit of little divergences in prices and trade

on rapidly as well as in massive capacities. With the advancement in computer systems, there is

an increase in the size of the trading practices and algorithms also become more refined. It is

argued that trading costs for small investors can be reduced due to an increase in market

effectiveness and liquidity (Linton & Mahmoodzadeh, 2018). Profitability is one of the benefits

obtained from the execution of HFT in trading firms. It is analyzed that HFT strategies enhance

market liquidity as well as market efficiency for investors and borrowers.

A challenge identified if HFT used unethically is that it would give an imbalanced benefit

to traders if they engaged in the influence of the market. For example, Trillium capital is one of

the HFT firms in New York involved strictly in HFT trades. It has moved in many trades, which

were deliberated as non-bonafide. In addition, the placement of orders was to mislead the market

into discerning as there was a large sum of activity that occurred in specific securities. These

orders have persuaded other traders based on the vision of supply and demand developed by

Trillium. The corporation had limit positions and cancelled the non-bonafide traders to obtain

profit from limit orders. However, these kinds of traders are illegal and caused market activities.
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Therefore, investors, as well as regulators, concern about the chance for illegal as well as

unscrupulous trading activity that HFT offers.

It is argued that HFT practices can be prejudiced to small investors because they do not

have adequate resources. The primary aim of HFT is to provide users a competitive benefit and

positively affect brokers, analysts, large trading firms, and small investors (Van Kervel &

Menkveld, 2019). It is crucial for traders to overcome the challenges of HFT by using effective

strategies.

The traders need to have a fast and robust structure in order to implement high-frequency

trading to acquire competitive advantages. HFT has become an essential part of the financial

market because of the convergence of different factors such as the increasing complexity of

financial products, the growing role of technology in the current market, and lower costs of

transactions. Increasing the use of HFT lead to systemic risks imposed on the financial system

due to high volatility and uncertainty.

Conclusion

The paper demonstrates the benefit and challenges of HFT in the financial market and

other market conditions. HFT is an innovation that utilizes computers to leverage financial data.

It is recognized that HFT increases market efficiency and enhances market liquidity. Moreover,

it is useful for trade investors, traders, and other market participants to gain competitive

advantages. It uses trading strategies to trade securities rapidly and, thus, need to overcome the

challenges posed by the HFT to the financial system.

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References

Baldauf, M., & Mollner, J. (2020). High‐Frequency Trading and Market Performance.  The

Journal of Finance, 75(3), 1495-1526.

Kirilenko, A., Kyle, A. S., Samadi, M., & Tuzun, T. (2017). The flash crash: High ‐frequency

trading in an electronic market. The Journal of Finance, 72(3), 967-998.

Linton, O., & Mahmoodzadeh, S. (2018). Implications of high-frequency trading for security

markets. Annual Review of Economics, 10, 237-259.

Van Kervel, V., & Menkveld, A. J. (2019). High‐frequency trading around large institutional

orders. The Journal of Finance, 74(3), 1091-1137.