What is High Frequency Trading (HFT) in Crypto?

What is High Frequency Trading (HFT)? High Frequency Trading refers to a trading method that utilises computer programs to conduct a broad number of orders in just fractions of seconds.  Also known as algorithmic trading, it presents a type of computer-based trading where the algorithm makes decisions such as price, timing or even executes the order without any human interaction.   As complex algorithms are used to analyse markets and execute orders, High Frequency Trading strategies are used by banks, pension funds, mutual funds, hedge funds and other institutional investors and traders within the sphere of the traditional financial system.  Essentially, this type of algorithmic trading is able to facilitate broad trading volumes in a short period of time while also keeping track of market movements. 

History of High Frequency Trading (HFT) From the first stock exchange opened in Amsterdam in 1602 to a highly digitised and modernised market, we have seen many changes in trading strategies and the entire system. In our recent history we have seen another development in trading due to the High Frequency Trading (HFT) method. Ever wanted to buy cryptocurrency stocks? To find out more, take a look at this article: ‘Where to buy cryptocurrency stocks?'.  It was initially developed back in 1983 when NASDAQ laid down an electronic form of trading. However, with the development of computer processing power, it became possible to execute large trades in microseconds.  The real introduction of this type of algorithmic trading took place in the early 2000s when improvements in computational power enabled more high-speed and high-volume trading activities. The notion of earning profits in a shorter amount of time attracted many investors and this trading strategy soon became very popular.  Additionally, HFT assumed an important role following the 2010 flash crash in the United States. The so-called flash crash which took place on 6 May 2010 was a trillion-dollar crash of the stock market that started at 2:32 p.m. and lasted only 36 minutes. Today, HFT is more considered as an application of technological improvements than a trading strategy. By applying technological developments to market data access and order routing, it tends to maximise the returns of multiple trading opportunities and methods. Most of these strategies are, for example, founded on market liquidity, price discovery or market efficiency.  Why has it been criticised? Despite the praises, High Frequency Trading has also been deemed controversial by many industry experts and market participants. HF trading replaced human interaction with algorithms to make decisions that happen in a fraction of a second. Due to this trait, it has been called ‘ghost liquidity’ – in other words, critics said that liquidity is available to the relevant market one second yet gone in the next one. The result is that it is not stable and that traders cannot trade such liquidity.  HFT has also been criticised for weaker risk management controls due to time constraints in conducting trades without substantial security checks. For example, back in 2012, the Chicago Federal Reserve posted that some High Frequency Trading firms didn’t take time to develop and test their code and got algorithms that were allegedly out of control.  While some people claim that High Frequency Trading positively affects financial markets because it increases the volume of available assets, critics think that the liquidity is deceptive. They also state that it is linked to market manipulation since HFT algorithms can be used to create a false presence of high or low demand in the market. Additionally, the market can be overwhelmed by a broad number of buy and sell orders and slow down other market participants. How does High Frequency Trading work? Think of a regular stock with a stable price. There is no particular news or trends related to that stock, but there are a bunch of small trades. For example, some investors may think it is overpriced, and others may think it presents a good investment opportunity. Several other investors need cash and want to sell it. Therefore, now we have many orders, either buy or sell and the price is still steady.  However, most of these investors were individuals. Now imagine that institutional investors are doing the exact same thing with the same stock – they are buying and selling, but their trades are big. For example, if a pension fund places an order for buying, it could purchase millions of shares instead of hundreds.  When a trade of big quantity occurs, the market is affected by it and can go up or down. That brings us to High Frequency traders who seek to profit from these price movements that stem from broad institutional trades. In other words, HF traders aim to purchase when the price is below the trend and sell when it is above the trend, and this needs to happen rapidly.  To succeed in this task, a broad amount of market data needs to be assessed. High Frequency Trading firms look at market data as well as market liquidity and make trades rapidly by using complex algorithms and technological solutions. They need to implement different trading strategies to take advantage of market movements and generate profits based on high speeds and high frequency trading. Main components of High Frequency Trading strategies The simplest explanation of HFT is based on collecting small gains on short-term market fluctuations. HFT firms search for temporary inefficiencies in multiple markets and trade as quickly as possible. Because of this component, HFT is often featured by high turnover and changing market conditions.  High Frequency Trading depends on ultra-low latency which refers to trades conducted in less than 1 microsecond. If HFT firms and traders want to gain profits, their algorithms need to acquire data faster than their market competitors.   We have already mentioned how HFT is based on technological advancements. Therefore, High Frequency traders need to constantly upgrade their technology to stay ahead of their market rivals.  In the world of High Frequency Trading, speed and innovative technological solutions are the secret ingredient of winning. Today’s financial and crypto markets are both volatile and constantly changing – this means that algorithmic trading strategies can change within minutes. What is High Frequency Crypto Trading? Even though High Frequency Trading emerged in traditional finance, it has made its way into the cryptocurrency market due to technological advancements and price fluctuations within the crypto space.  HF trading reduces small bid-ask spreads by conducting large trading volumes rapidly. This enables traders to take advantage of price movements before they can be fully seen in the order book. Therefore, HFT can gain profits even in highly volatile markets such as the crypto market.  HFT strategies were tested on cryptocurrencies in a 2020 research which demonstrated that momentum trading can be used successfully within the cryptocurrency environment in a high frequency setting.   It is simplified within crypto markets since assets can be traded on decentralised exchanges (DEXs). Since decentralised exchanges don’t share the same centralised structure as centralised crypto exchanges and traditional financial exchanges. In other words, the emergence of HF trading strategies within DEXs seems like a natural development of things.

The popularity of HFT can also be seen in crypto hedge funds implementing algorithmic trading to gain profits. To learn more about crypto hedge funds, why not read this article: ‘A guide on crypto hedge funds'. Common HFT strategies on the crypto market It can either be stated that HFT is a strategy in itself or that it is just the application of technological solutions to existing trading strategies. However, it is linked to several common trading strategies and proper market analysis techniques. Let’s explain them briefly.  If you are new to the crypto trading space, we suggest checking out the crypto trading course on our Learn Crypto Academy. Crypto arbitrage strategies Arbitrage refers to the process of gaining profits by taking advantage of price discrepancies for the same crypto asset on divergent crypto exchanges.  HFT helps arbitrage traders to rapidly secure short-term opportunities; simply put, the window of financial opportunity is typically small, and sophisticated algorithms used in HFT can analyse markets quickly.   Therefore, arbitrage traders can take advantage of price differences before anyone else by utilising HFT algorithms. Market making Market making refers to placing buy and sell orders for a certain asset at the same time and making profits from the bid-ask spread which represents the difference between the price the buyer is willing to pay for the asset and the price at which the seller is willing to sell the asset in question.  Market makers are constantly involved in buying and selling digital assets – therefore, HFT algorithms can help market maker companies to profit from the spread. 

Volume trading Volume trading refers to tracking the number of assets traded in a certain period in time and then conducting trades based on that market data. It is based on the presumption that as the number of assets traded increases, the liquidity increases as well, which makes it simpler to conduct broad trades without affecting the relevant market too much.  Should you try High Frequency Trading in the cryptocurrency market? Whether we are talking about HFT within traditional financial markets or the crypto market, it is not as easy as it seems. It involves the use of computer algorithms and computational power to place fast trades at a very high speed. As mentioned in the part about HFT’s components, HFT firms need to update their algorithms constantly to stay ahead of their market competitors.   Potential investors and traders need to be well-educated on this matter to reach informed decisions. You must fully understand all the technology as well as advantages and disadvantages of HFT before deciding to take part. It is crucial to do your own research and be financially responsible before making any moves within a highly volatile market such as the cryptocurrency market.