High frequency Trading Tutorial For Dummies (2023 Update)

15 Price Action Patterns Insiders are Using If a hedge fund managers were using 15 specific price action patterns would you want to know?

If you want to learn how high-frequency trading works, you have landed in the right place. High-frequency trading algorithms now account for between 50% and 70% of all trades that happen in the market. These trades are not executed by a human being or as a result of a human decision. Theyโ€™re executed by an algorithm at a speed rate and scale thatโ€™s beyond our comprehension.

If you are interested in high-frequency trading (HFT) then this High Frequency Trading Tutorial is for YOU!

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Trading has become inhumanly fast. In the HFT world, we only deal in microseconds. High-frequency traders might do thousands of trades in a minute. However, most of these trades are only computers testing the markets.

They simply fire up a bunch of buys and sell orders and when another computer algorithm bites on one theyโ€™ll quickly cancel the ones that didnโ€™t stick. All of this happens on a microsecond basis.

Some high-frequency trading algorithm has the sole purpose to combat other HFT algos and take them out.

Back in the day when humans still ran the trading pits the average time that it took to execute a trade was around 11 โ€“ 12 seconds. The basic law of the market is that the fastest will usually win. There is always a benefit to getting information faster than the other market participant.

High Frequency Trading

Letโ€™s say the non-farm payroll (NFP) report is coming up! If the employment numbers are strong it can help the stock market to push higher. If you can get the numbers in advance and rush to the market before anyone else gets there and buy the stock before it goes up you can make lots of money.

Nowadays with electronic trading, the law of the market works the same but at another level of speed!

Moving forward, youโ€™ll learn how high-frequency trading works and how you can front-run the high-frequency trading strategies and get in before the algo runs the markets.

Letโ€™s continue with our high frequency trading tutorial.

High Frequency Trading Tutorial โ€“ How It Works

High Frequency Trading Algorithm

What is high-frequency trading?

Essentially, high-frequency trading, or HFT is fast trading through the use of very powerful computers. The high-frequency trading algorithm has an inconsiderable advantage in the market because it allows them to trade extremely quickly.

To understand our high frequency trading tutorial, you need to understand the terminology used by HFT traders:

  • Collocation
  • Algorithms
  • Program Trades
  • Automated Market Makers (AMM)
  • Flash orders
  • Front Running

Collocation is when these HFT companies put their servers as close to the servers of the exchange theyโ€™re trading on. Collocation is crucial because it makes the transactions move quickly.

If there is very little distance for the orders to travel it speeds up the transactions.

Letโ€™s take as an example an institutional trader that wants to buy 1,000 shares of GE which are trading at $10.50. He doesnโ€™t want to pay more than $11 for the GE shares. So he has a $0.50 range to play with. However, he canโ€™t go straight into the market and show up his hands because other investors, particularly the HFT traders can see and manipulate the price of GE stock.

High Frequency Trading Algorithm

Our institutional trader can create an algorithm or computer program to break his orders into little bits. For example, he can choose to break his big order into 10 blocks of 100 shares each. Also, he will instruct his algorithm to not buy higher than $11 a share.

High Frequency Trading

The high-frequency trading algorithm is also out there and it can detect what is going on in the market. They can see these blocks of 100 shares coming into the market and realize that some investors are buying in bulk.

These HFT algos then deploy their automatic market makers into action and starts to send offers into the market.

The way the high-frequency trading strategies works is something like this:

The HFT algo first starts and sends an order of 100 shares at $13, but nothing comes back because the other algorithm is programmed not to buy higher than $11. The HFT algorithm immediately cancels that order.

The HFT algo tests the markets again and sends another order for 100 shares at $12, but nothing comes back and the order is immediately canceled.

This all happens in a fraction of a second.

The HFT algo will keep testing the market until he hits the $11 mark. Then the offer is lifted and the automatic market maker algo immediately goes out and buys as many GE shares as he can and it comes back and sells them at $11 to the other institutional investor.

The reason why he is forced to sell at $11 is that there are no other shares left in the market at this point because the AMM has dragged all the available shares and therefore can manipulate the price and force the price upwards.

There are various types of high-frequency trading algorithms built to take advantage of price movements in the market and also to juice the market.

Another weapon that these HFT programs can use is flash orders.

Whenever an order comes into exchange the stock exchange is required to send that order right to the wider market. Or, it can simply flash the order to the stock exchange members.

When an order comes into the stock exchange, if the exchange uses flash order, then just for a fraction of a second it flashes that trade or that order to all the investorsโ€™ members within the exchange. They have the split-second option to fill that trade or if not the order is then sent to the rest of the market.

Hft Programs

This gives the exchange members an advantage because they get to see the orders before anybody else and front-run these trades.

Front running is simply knowing someoneโ€™s about to buy some stock shares and then quickly buying up as much as possible to sell it back to them at a slightly higher rate than you bought it for.

Conclusion โ€“ High-Frequency Trading Tutorial

A lot of hedge funds and investment banks have made a great deal of money from the high-frequency trading algorithm. We hope this high-frequency trading tutorial has made some light on how these complex programs have become to rule the markets. Even though crypto is a relatively new market we can find high-frequency trading cryptocurrency algos even there.

High-frequency trading uses astronomical speeds because they are all competing with other HFT algorithms. This is a game of speed and whoever gets there first, gets the gold. Time will tell if the ultra-fast algorithmic trading will benefit us or hurt us.

But we have to keep in mind that really bad stuff can also happen as a result of the HFT algo actions which are to be blamed for the flash crash of May 2010 when in less than 1 hour the most important stock indices in the world lost 1,000 points.

Thank you for reading our High Frequency Trading Tutorial!

Feel free to leave any comments below, we do read them all and will respond.

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High Frequency Trading Infographic

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15 Price Action Patterns Insiders are Using If a hedge fund managers were using 15 specific price action patterns would you want to know?

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  1. Great wordpress blog here.. Itโ€™s hard to find quality writing like yours these days. I really appreciate people like you! take care

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