High-frequency trading (HFT), which first gained notoriety in the equity markets, has lately become more prevalent in the foreign exchange (FX) market. This development is a part of a larger trend made possible by the increased usage of electronic foreign currency trading, both at the consumer level and in the broker-dealer market. With trade execution times measured in milliseconds and high volume but small order sizes, low margins, low latency, and brief risk holding periods (usually well under five seconds), HFT in FX operates. As a result, it mostly happens to the currencies that are the most liquid. Although the major currency pairs have seen the most HFT activity to date, it has the potential to spread to other reasonably busy trading currencies, such as several developing market currencies.
What is High-frequency Forex Trading?
One specific facet of a larger trend in the foreign exchange (FX) market brought on by information technology advancements and the proliferation of electronic trading is the emergence of high-frequency trading (HFT). The foreign exchange market predominately consisted of broker-dealers before the 1990s. The majority of transactions happened at the market’s inter-dealer center.
The second or outer tier of this market, where activity between dealers and their consumers took place, was characterized by greater bid-offer spreads than the inter-dealer market. Transactions and quote requests were primarily conducted over the phone (or “voice”). The inter-dealer market underwent a change in the 1990s with the introduction of electronic broking and trading.
However, the line dividing this invention from the inter-dealer market persisted because it was not yet available in the consumer market. This line was blurred when, in the early 2000s, FX customers had more access to electronic trading, when FX dealing banks started to provide clients with trading services through electronic portals (single-bank or proprietary trading platforms), and when the use of credit sponsorship through prime brokerage agreements increased. The over-the-counter (OTC) FX market now allows a variety of client types to engage on a more or less level playing field in terms of pricing.
There are two primary categories of electronic trading: Manual, in which human beings use an electronic trading platform to carry out instructions; and automated trading, in which computer algorithms carry out instructions with little to no human involvement (albeit still under human supervision).
Is High-frequency Forex Trading Legal?
High-frequency trading is legal, yes. However, it’s likely that your broker won’t let you use high-frequency trading techniques. Some brokers completely forbid price-driven tactics (like scalping) or latency-driven arbitrage strategies. To find out if your HFT technique will be permitted, you should speak with your broker directly. It’s also crucial to thoroughly review your broker’s terms and conditions.
In the event that your broker does allow HFT tactics or systems, it’s crucial to be aware of the exact kinds of trading circumstances that are offered as well as your broker’s execution procedures and trading fees. High-frequency trading might not even be possible even if your broker allows it if they make it too expensive.
HFT systems are debatable even though they are legal. Some well-known HFT techniques, such spoofing and front-running, are simply prohibited.
Spoofing: Spoofing is the quick placement of numerous orders by a high-frequency trading system followed by the cancellation of those orders before execution. The goal of this tactic is to inflate the perception of demand for a certain asset or instrument (or falsely driving demand downwards).
Front-running: HFT traders (or institutions) may occasionally be able to spot important pending orders for a particular asset or instrument in the market before the orders are carried out. When doing this, insider (or, non-public) knowledge is usually used unlawfully. The speed of HFT systems allows these traders or institutions to buy large quantities of that asset fast, which they can later sell for a profit.
Having said that, over the past 20 years or so, laws and procedures have been implemented to safeguard market players, prevent unethical actions like front-running, and generally uphold market integrity. For instance, in an effort to level the playing field, several securities exchanges have put in place a general speed bump that slows down all incoming orders. Many forex market firms and trading venues today completely forbid HFT methods that are latency-driven or just focus on price arbitrage.
Advantages of High-frequency Forex Trading
Trading with great speed on the foreign exchange market is the main advantage of HFT trading. The quickness with which HFT players identify and take advantage of lucrative trading chances in the market distinguishes them from other algo decision-makers. Co-location, or trading firms placing their servers as close as feasible to the trading venue, has become popular because speed is of the essence.
As of the time of writing, market contacts indicate that some HFT participants in FX can operate with latency of less than one millisecond, as opposed to most upper-tier non-HFT participants, who typically operate with latency of 10 to 30 milliseconds (for comparison, it is said to take a human about 150 milliseconds to blink). According to market analysts, additional latency reductions are expected to be expensive and may only provide a small financial gain.
The opportunity to profit only from being able to trade with low latency is anticipated to decrease as more and more HFT participants enter the market to take advantage of these possibilities or as non-HFT market participants upgrade their systems and lessen their speed disadvantage. It appears that this process is already in motion. As a result, some HFT businesses are allegedly starting to rely less exclusively on tiny, low-risk trades and are starting to diversify by leveraging their advanced algorithms to engage in more conventional (directional) risk bets.
Trading at a Low-Frequency
Low frequency trading, in contrast to high frequency trading, entails a very small number of trades executed over a monthly cycle. Typically, this is due to the fact that these trades are built on long term charts (like the daily charts), take longer to develop, but ultimately look to try and produce higher returns on investment.
On the daily chart, a trade can be built that could take up to two weeks to execute. Consider this: which is superior? pursuing several deals that only yield 20 or 30 pips per trade in profit with a higher risk of loss, or taking four trades per month with the potential to provide up to 400 pips on a trade?
The daily chart is a stronger predictor of the trend than short term charts, as all position and long-term traders are aware. Major trends are those that continue more than six months, followed by intermediate trends, which are essentially corrections of the primary trend, and small trends, which serve as noise on shorter timescales.
The upside retracement (intermediate trend) that appears to be an uptrend on a short-term chart may really be one on a daily chart. Low frequency traders, who are truly waiting to sell on the short-term rally in the direction of the underlying trend, will blow off course high frequency traders who utilize the erroneous information provided by the short-term charts to go long. Because institutional traders, who control the volume of the market, trade on long-term charts, it is as if a strong river current is blowing a little boat away. A small boat can only be used on a river when there is no countercurrent. Even the strongest tiny boat rowers will be swept off course by the current once that powerful countercurrent arrives.
Advantages of Low Frequency Trading
- Your eyes and general health benefit from spending less time in front of a computer screen.
- Trading with the trend can increase your chances of success. Instead of manually rowing against a strong current, it is like using the sails to make the wind work in your favor.
- You have less work to do in trading.
- For each trade, the potential reward-to-risk ratio could be higher.
- Compared to high-frequency trades, low-frequency trade setups often have a significantly higher likelihood.
- You have more time to spend on the important things in life.
High-frequency forex trading is not for the timid; we’re talking about millions of trades involving enormous sums of money, executed by sophisticated software on powerful equipment! Keep in mind that not everyone can participate in high-frequency forex trading, but depending on your level of computer proficiency, you might be able to. It’s crucial to comprehend high-frequency trading and how it affects the market as a whole, even if you personally have no plans to start any.
If you are looking for a retail forex broker with fast execution and tight spreads for your HFT strategies, IC Markets would be my top choice. They have tight spreads, low fees and quick execution speeds at the best available prices within a deep liquidity pool. This makes them my top choice for both manual and automated forex trading strategies.
Self-confessed Forex Geek spending my days researching and testing everything forex related. I have many years of experience in the forex industry having reviewed thousands of forex robots, brokers, strategies, courses and more. I share my knowledge with you for free to help you learn more about the crazy world of forex trading! Read more about me.