High-frequency trading, sometimes called HFT, is a hot topic among the trading community, as well as among ordinary people concerned about the consequences of this type of trading practice.
High-frequency trading can be defined as automated trading using ultra-fast execution (milliseconds or even microseconds), holding trades for very short periods, trading with low position sizes and targeting small profits from each trade. Unfortunately, there is very little information available about high-frequency trading in general, and even more so when it comes to the forex market. The Bank for International Settlements report on high-frequency trading is the best introduction to this type of practice among forex traders, noting that the report is relatively old.
There are a number of misconceptions about high frequency trading:
- High frequency trading is illegal.
There are currently no laws that make high-frequency trading illegal, nor does it necessarily involve any illegal activities (e.g. insider trading).
- Traders who engage in this type of trade can use special types of orders that cancel themselves when the counterparty accepts the order.
High-frequency trading does not provide access to these special orders, but they can imitate the same behavior by using a large number of small orders and quickly reacting to the actions of other traders.
- Only large hedge funds and investment banks benefit from high-frequency trading.
In practice, the opposite is true — most of those involved in high-frequency trading activities are relatively small companies rather than large financial institutions.
- High-frequency trading had no risk.
In fact, researchers and financial market professionals classify this type of trading as fraught with a high degree of risk. Any disturbance in the infrastructure of this system can greatly affect the performance of high-frequency deals.
Here are some facts about high-frequency trading:
- Co-location, which means the trader’s proximity to deal execution centers, is crucial to take advantage of fast deal execution as a competitive advantage.
- High-frequency trading is self-regulated (as is the entire forex market). This type of trading is subject to the company’s internal risk management regulations, and the brokerage company monitors it to ensure that its traders apply the rules of the trading platform.
- Given that the forex market is fragmented by nature, high-frequency trading firms are beneficial in terms of enhancing system liquidity between various electronic communication networks and platforms. It is estimated that the total share of high-frequency trading is less than 25% of the total transaction volume of the spot forex market (USD 7.5 trillion in April 2022).
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