In recent years, trading through the foreign exchange market known as FOREX has gained great relevance and strength. Large amounts of money are moved daily through this market to the point that the number of currencies converted daily can cause the price movements of some of the transactions to be extremely volatile. It is precisely this volatility that makes forex an extremely attractive market for investors, as it provides greater opportunities to maximize profit, but also increases risk.
Forex is a market made up of currencies from all over the world and its predictions can sometimes be affected by various factors. One of the factors that most affect this financial market is mainly the law of supply and demand, it is of utmost importance to understand what causes price fluctuations and how they can be counteracted.
This is where High-Frequency Trading (HFT) comes into play, in the financial field it is known as a type of trading where a large number of purchase and sale transactions are made in just seconds. But what is high-frequency trading? How is it possible that thousands of transactions occur in a fraction of a second? What are its advantages? Below we will help you to clarify your doubts regarding this topic.
What is High-frequency FOREX trading?
High-Frequency Trading (HFT) is a type of automated trading that employs very complex algorithms. This establishes an entry barrier that makes this type of trading generally not accessible to retail traders. This is nothing more than a type of algorithmic trading in which orders to buy and sell financial assets are placed in a matter of milliseconds, automatically of course. However, although the orders are launched into the market, not all of them are executed.
The incredible speed with which orders reach the market is only achieved by very powerful supercomputers using complex algorithms. This work requires both professional software and hardware specifically designed for this task. They are usually equipped with expensive high-tech equipment. Hence, this type of trading, although anyone can do it given the proper technology, is usually in the hands of hedge funds and investment funds.
General characteristics of High-Frequency Trading
The technology used is high-end and very sophisticated, a retail investor would not be able to reach such standards since the investment becomes quite high.
The machines or robots used for high-frequency trading are physically located in the trading centers so that the orders that are exchanged in the markets arrive as soon as possible, without any delays.
Whether executed or not, orders do not remain open at the end of the session.
Each operation gives a minimum profit, hence the idea that thousands of orders are opened and closed many times over in short intervals so that the sum of all of them, represents a much greater potential profit.
This type of trading is considered by some experts as a type of “market manipulation” because its thousands of transactions per second can create micro-trends that can affect the market in general.
The volume traded in the markets by these automated traders reaches very high levels. Especially when we talk about the daily trading volumes of liquid markets.
What are the risks of high-frequency trading?
Although it is a practice that is becoming more common every day, like everything that includes high movements of money, it involves some risks that are worth evaluating before deciding whether to carry it out or not:
* Operational risks: Because it involves physical technology, it can be affected by technological problems, for example, hacks or failures in the networks that are interconnected.
* Market integrity risks: as mentioned above, for some, this type of trading is considered market manipulation and if used in an uncontrolled manner, it can seriously affect the market. For example, in 2014 the SEC accused a high-frequency trading company of using an algorithm to manipulate the closing prices of Nasdaq stocks. This practice would have occurred in 2009 and eventually, the firm had to pay a fine.
* Risks to financial stability: As well as posing a risk to market integrity, because it is not real investors but an automated system, it can inspire distrust in those who want to trade.
What are the solutions to these risks?
Possible solutions to these risks include:
* Keep regulations and updates up to date.
* Limit the number of orders and trades that are carried out.
* Limiting the time to keep executing trades in the market.
Advantages of high-frequency trading.
* High-frequency trading floods the market with liquidity.
* As a consequence of the first advantage and the increase in trading volume, this type of trading reduces spreads, the difference between the bid and ask price.
* No intermediaries are needed, orders go directly from supercomputers programmed with algorithms to the market.
* It reduces volatility by controlling the market trend at times.
Disadvantages of high-frequency trading.
* Its transactions are based solely on technical analysis, they do not take into account fundamental analysis.
* It is not accessible to any retail investor, it is only reserved for large banks, investment funds and hedge funds, businesses that have at their disposal the latest technological advances, and most importantly, have the capital to hire the best programmers.
* They can cause collateral damage to other investors or generate overpricing.
* The high speed with which they launch automated orders gives them an advantage over other retail traders.
Because of the way high-frequency trading is used, it is currently regulated. In the United States, for example, the “Dodd-Frank Act” was passed in 2018 in the wake of the financial crisis experienced in 2008. In addition, in this country, investigations in search of fraudulent transactions were considerably increased to avoid indiscriminate manipulation of the markets.
As we have already indicated previously, high-frequency trading is specially designed for large investors, it is simply not within the reach of any retail trader. Fortunately for them, there are Contracts for Difference (CFDs), products derived from High-Frequency Trading, which allow speculation on the price movement of assets, regardless of whether it is up or down.