What is High-frequency trading? Complete Disscusssion

High-frequency trading is a technique that includes specialized software and algorithms, high-end computers, low-latency Internet access, and current market data to outperform the competition and enable unique strategies that would otherwise not be possible.

High-frequency trading (HFT) is a system in which algorithms and software execute several trades per second and that offers a number of advantages that are not available to regular traders. It existed long before the cryptocurrency and is believed to account for up to 80% of its volume in certain asset markets. However, now it is becoming an important factor in the world of decentralized assets as more and more institutional investors are drawing attention.

The principle behind most HFT strategies requires that those who execute them be first - and sometimes it only takes a fraction of a second to turn a profitable step into an unprofitable one. This has developed into some specific techniques that make this type of trader slightly ahead of the competition.

This can certainly include the latest and most powerful devices, but it also requires the development of very clever methods to work within the minor variables available on the market and to use them in millisecond turnarounds.

Techniques and strategies can include colocation, market-making, arbitrage, ping, and news-based trading. Each option comes with costs and benefits, and depending on market conditions, traders may not always have all of the strategies available.

Of course, there are still some debates about whether it is ethical to create unequal competitive conditions. Of course, some of these strategies are illegal or heavily regulated in traditional markets. It is true that the cryptocurrency is still in a “wild west” phase, but this is changing quickly and traders should be aware of their local laws before engaging in this type of activity.

Colocation

Colocation refers to the practice of placing a trading server as physically close to a data center as possible - sometimes in the same facility - to delay the transfer of market data as little as possible.

With regular exchange, every user is exposed to risks associated with communication delays. For most retail investors, these minor processing delays have little impact. For the high-frequency trader, however, milliseconds can be anything. An obvious way to gain an advantage is to use the best equipment.

Another option is to physically place your own trading server near the data center that powers the exchange you choose. In some cases, users literally set up a store in a data center environment. However, these exchanges often offer the possibility of accommodating private servers for those interested on site.

Customers can even connect directly to the main server, and those who implement this option do not have to connect over the Internet, which significantly reduces transmission delays. This approach is known as "colocation" and can easily save time for data transfer latency to give significant benefits to everyone who uses it.

There are already a few exchanges in the cryptocurrency offering this type of connectivity. For example, exchanges such as HitBTC, Gemini and ErisX have had colocation options available to customers for over a year. In this way, HFT strategies can be used by companies that are not physically close enough to the data centers that they need access to. In general, colocation is an important building block for conducting this type of trade because it always offers an advantage over those who are further away from the access point.

Market Making

Market making is a common strategy in the retail world. This is the case when a trader with sufficient resources makes both bids and requests in the same market, which provides liquidity and effectively makes a profit based on the spread.

Market making in regular trading is usually provided by large companies and is generally seen as a positive practice to keep key markets sufficiently liquid. By providing large orders on both sides of the order book, manufacturers ensure that other customers can make money at any time. It is common for a large exchange to have contracts with one or more market makers

Arbitrage Trading

Arbitrage is the process of taking advantage of a price difference for the same asset across multiple markets.

Occasionally, a single asset may show price inconsistencies on different exchanges. Recognizing and taking advantage of these differences is a common source of profit for traders. These opportunities occur more often in cryptocurrency due to increased volatility, but are quickly eliminated by regular market forces as all traders should have access to these opportunities.

However, HFT practitioners can first identify and use these situations. By using software that can identify these discrepancies in real time, they can respond in response to orders hundreds of times faster than a regular retailer. There are several ways to use the arbitrage strategy, but all involve recognizing variability in a market and jumping into it for the first time. It can rightly be said that the more efficient traders benefit from arbitrage, the less profitable it becomes on average.

Pinging

Pinging is a process in which HFT users use a number of smaller jobs that run very quickly to find larger jobs that are “segmented” or broken up into small pieces so as not to affect market prices too much.

This method essentially tests a price range using small orders to find out the high and low range for which a large mover tries to sell. Since the means for recognizing these commands are coded in algorithms, they can search for these possibilities several times per second. The software can then use its increased speed to buy the asset immediately at the bottom of this area and sell it to the "loot" at the top, making an immediate profit.

Admittedly, this technique mainly feeds on large movers and is often used in places known as “dark pools”. Dark pools are either private exchanges or forums that do not report their order book in real-time. Regulations typically require the disclosure of transaction information, but it can be delayed long enough for large institutional users to do big business without directly impacting the market. However, these systems are prepared to be victimized by radiofrequency traders who can use ping to spy on and act against other dark pool users. This can affect the profits of traders who are not high-frequency and undermine the benefits of using a dark pool.

News trading

News-based trading is simply buying or selling in response to press releases on market wealth.

Most traders have used the news at one time or another to inform their trading strategy - it is almost impossible not to do so. For most, the news is a fair competitive environment as the general public should have access to this information at about the same time. The use of information that has not been made public is considered "insider trading" and is generally illegal, although it is still widespread.

The way HFT progresses here is that it can use modern software to analyze messages in the seconds after they are interrupted and then immediately place orders in response. The software is intelligent enough not only to determine which asset is being discussed, but also whether the news is positive or negative. While this is clearly not an insider trade, it could still be a massive advantage over any trader who has to process the story and decide how to react.

Conclusion

While high-frequency trading may not be for everyone, it can definitely offer new techniques that tech-savvy and adventurous traders can enjoy. It is true that it will be important to know the regulations and keep them up to date as the cryptocurrency space evolves. However, it is highly unlikely that HFT as a whole will soon go away. There is much more to learn, but with the right tools and techniques, everyone has the opportunity to use this method.