What is high-frequency trading?
When you start investing, you will run into many new terms. High-frequency trading is probably one of them. Stock market trading has changed a lot since the rise of high-frequency trading, but what exactly does that term mean?
Speed is essential
High-frequency trading is a way of acting with enormous speed. Powerful and fast computers scan the market for the high-frequency trading itself. At this speed you have to think of thousandths of seconds. The computers scan the market in search of market movements with which they can earn money.
Algorithms and stocks
High-frequency traders constantly search for the right algorithms. For example, if you want to buy Shell stocks as an investor, you can see that another buyer is buying blocks of Shell stocks. But the high frequency trader does not yet know which investor this is, and at what price this investor wants to buy. To find out, the automatic market maker (AAM) is put into operation. This imposes sales orders for the Shell stock that are higher than the current price.
However, the order will not be executed if you have previously recorded that you do not want to pay more than a certain amount. AAM searches through all sorts of prices until it has found a price that is favourable to the seller and that is not above the price of the other buyer. This whole process takes place in thousands of seconds. If the AAM has determined the limit price, it buys as much stock as possible and resells it.
Trading for professionals
It is mainly the very rich investors and large banks that engage in high-frequency trading. This has to do with the large investments that are necessary for this. For example, the banks’ servers have to be as close as possible to the servers of the institutions where they trade. Only over a really small distance is a super-fast information flow guaranteed.
High-frequency trading also requires highly trained people who develop the necessary programs and models. Often these people are expensive to have on the payroll. Finally, of course you need fast computers and programs above all else.
The consequences for the private trader
Obviously, high-frequency trading also has consequences for the private trader. Computers often leave the human factor out of consideration and only focus on orders and on certain technical levels. A large part of the trading of stocks, Forex and commodities is carried out by computers: in the end these programs influence the price.
Many people therefore wonder how technical indicators and levels can often be kept. This is largely because people and especially computers maintain these levels. Because the levels are used for opening and closing positions, it is possible to recognize patterns. Ultimately, computers therefore contribute to the predictability of the market.
Should you engage in high-frequency trading or not?
Proponents of high-frequency trading claim that this way of trading gives liquidity to the market. Ordinary investors who want to get out of the market can always find a buyer due to high-frequency trading. However, there are also opponents of high-frequency trading.
The opponents claim that the liquidity of high-frequency trading is greatly overestimated. In addition, they point to the fact that in a declining market buyers are rarely found and that high-frequency trading cannot provide answers to this.