HFT in Financial Markets: How it works and What is the Problem with the System?

November 9, 2016

Majority of orders in our financial markets are made by HFT, creating a huge black market.

HFT in Financial Markets: How it works and What is the Problem with the System?

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Our financial markets are growing very rapidly including Forex, Stock and Commodity market.

As the technology makes it easier to reach out for us, the trading volume has been also increasing about 10 times from 5 years ago in total.

Although the number has been increasing in each financial market, some market analysts mention that “the actual trading volume is very thin comparing to the increasing numbers these years”. What does that even mean?

The reason of that is the existence of HFT.

HFT stands for High Frequency Trading, this trading method is possible by using some latest technology to trade thousands of traders in a second.

No one trades manually with HFT, but it is completely automated algorithm trading using their own programs.

Buy/Sell Orders in a few micro seconds

HFT is normally done by some financial companies or hedge funds, and it is very rare that they carry positions to the next day.

These companies are aiming to earn profits with no-risk, as in using HFT. So they normally trade very popular and liquidated stocks only.

HFT itself has started in around 1990 in US, it has been spread out to other financial areas and it is known that the share of HFT in US  Stock Market is over 70%.


HFT is also a target of accusation when a trouble happens.

You might still remember “the Flash Crash” happened in May, 2010 in the US Stock Market. That time, the NY Dow Index has dropped over 1000 dollars in a few minutes and many investors have blamed the activities of HFT for the trouble.

HFT isn’t popular just in US Market, but also in other countries such as Japan and Singapore.

Japanese HFT system “Arrowhead”

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Japanese Tokyo Stock Market, on the other hand, has started “Arrowhead” trading system in 2010.

The system improves the speed of execution to a few mili-seconds from a few seconds. The launch of the system was basically the beginning of HFT in Japan.

Tokyo Stock Market has also started another service at the same time, called “Collocation”. They have setup trading servers for brokers directly into the system center. By setting the server very close to the market, the execution speed has been improved to a few micro seconds finally.

With the launch of HFT in the market, the ones who are troubled with this is the dealers of stock brokers. Many of them had been trading manually, but now that cannot earn stable profits by doing the same thing.

Because there are some companies trading thousands of orders in a second, and the market moves to fast to see with eyes.

It is often that, when a dealer orders a position manually, the available liquidity doesn’t even exist anymore as HFT trading is taking them all.

In this case, HFT trading is causing losses to manual traders.

HFT does not take “Risks”, but how?

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Now that we all know that HFT is too fast and manual trading cannot beat them with the speed, many investors have started blaming the trading method.

Many Government Financial Authorities are very interested in looking into more deeper details.

One accusation against HFT is “HFT causing high volatile market movements”.

Especially the trading strategy called “Directional” is causing high volatile markets. HFT takes actions by gathering information of liquidity and the direction of market price, but not according to fundamentals or corporate reports.

This activity is suspected as adding more volatility in the market.

HFT orders and execute trades before other investors do. They can also take the whole liquidity for themselves and make sure that their orders are executed at the indicated prices.

HFT Trading is Unfair?

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HFT isn’t just fast, but there are several methods to make profits by doing HFT.

“Layering” is when HFT orders thousands of trades with different prices and different volume, and cancels them when other investor orders buy positions.

“Quote Stuffing” is when HFT repeats new large amount of orders, cancellation, modification of the orders in a second. This is known that used for manipulating stock prices.

In the US, “Front Running” is one well-known HFT activity. “Front Running” is when an investor compares the time gaps between different stock markets in the country, and makes small but large amount of profits by doing HFT.

It is of course an illegal trading methods among many financial markets.

The impact of HFT is still unknown

Although there are many companies using HFT programs in financial markets, although it is still unknown that it the HFT can affect the markets negatively.

We can bring up many examples of HFT causing losses to other investors, but none of them have been proved yet.

In a few years later, more details of the technology may be revealed more.

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