High-Frequency Trading Practical Manual: The Complete Guide to Mastering HFT Trading Strategies

High-frequency trading has become prominent in the investment world in recent years, with many traders and institutional investors viewing it as a key profit method. How exactly does high-frequency trading work? What impact does it have on the market? This article will analyze this complex and fascinating trading field step by step.

Definition and Mechanisms of High-Frequency Trading

High-frequency trading, abbreviated as HFT, originates from the English term High-Frequency Trading. It is a trading method that uses ultra-fast computers to enter and exit the market. Before computer technology became widespread, agile traders could perform “manual high-frequency” operations, but with technological advances, humans can no longer match the speed of computers.

Modern HFT is typically represented by market makers, who use high-speed computers to complete large numbers of orders within milliseconds or even microseconds. These trading algorithms can quickly generate quotes, manage risks, dynamically adjust prices, and continuously provide market liquidity.

The most notable feature of HFT is its extremely fast transaction speed and very short investment periods. This strategy’s history dates back to after the advent of computers. Early investors had to trade in stock exchanges physically, then remotely via phone, but the appearance of computers allowed investors to analyze market information rapidly and discover arbitrage opportunities across different locations. Institutions thus engage in HFT based on the principle that “price differences will eventually converge.” For example, if Bitcoin prices on U.S. exchanges are higher than in Japan, traders can sell in the U.S. and buy in Japan, then wait for prices to balance before recouping funds.

HFT also employs market psychology tactics to influence price movements. Some investors buy the target asset first, then place large orders that appear to be buy or sell orders, creating a false impression of “big players’ confidence,” attracting market follow-on buying, and pushing prices higher. HFT traders then withdraw their positions to profit from the spread. This approach resembles a market game, where profits come from price volatility itself. HFT does not need every trade to be actualized; instead, it uses market psychology to steer prices in the desired direction. Currently, HFT’s share of total market trading volume continues to rise, making understanding its mechanisms essential for all investors.

Dual Impact on Market Liquidity and Trading Costs

HFT has complex and contradictory effects on financial markets. Positively, HFT indeed increases market liquidity. Although many orders are fake or partial, a significant proportion are eventually executed, promoting market circulation, making stock trading more convenient, and attracting more retail investors.

On the other hand, HFT significantly increases market volatility. Since traders profit from market fluctuations, their strategies inherently aim to amplify price swings, regardless of direction. Many HFT algorithms operate automatically; during market turbulence, profits and losses are magnified, leading to phenomena that both push prices up and down.

Regarding trading costs, HFT involves high fees and taxes due to frequent transactions. While these costs may be negligible for large institutions, they represent substantial revenue for governments. Therefore, governments have not banned HFT; instead, they benefit from the tax income it generates.

The Legendary Story of Quantitative Investor Jim Simons

When discussing successful HFT cases, American mathematician Jim Simons must be mentioned. He founded Renaissance Technologies and created the Medallion Fund, which achieved an astonishing average annual return of 38.5% from 1989 to 2006, far surpassing traditional hedge funds.

Simons is hailed as the “King of Quantitative Investing.” Born in 1938, he earned a Ph.D. in mathematics at age 23, worked in intelligence and cryptography, and later became a master of geometry. Ultimately, he decided to apply mathematics to investing. Early on, he used complex mathematical and statistical models to capture tiny market price movements for high-frequency trading profits.

Renaissance Technologies grew into a team of hundreds of experts using sophisticated algorithms, executing all trades automatically with over 10 million lines of code, minimizing human intervention. By the end of 2019, the firm managed assets worth $130.1 billion. Even during the intense market volatility of 2020, this quantitative hedge fund achieved a 39% growth, with a net return of 24% after fees, demonstrating the powerful potential of HFT.

Markets Most Suitable for High-Frequency Trading

To execute hundreds or thousands of trades, the chosen assets must support such trading volume. Since each trade involves fees and taxes, these costs directly eat into profits. Therefore, markets suitable for HFT have two key features:

Large market size and excellent liquidity. HFT requires rapid entry and exit; a small or illiquid market hampers transaction speed and price, leading to slippage or failed trades. Additionally, the market should have sufficient volatility and variation to provide more trading opportunities and profit potential. Generally, larger markets with high liquidity and volatility are more suitable for HFT.

Low taxes and transaction fees. Due to frequent trading, high fees and taxes can significantly reduce profits. If costs are too high, they can wipe out gains or cause losses. Markets with lower taxes and fees are more attractive for HFT.

Based on these features, the U.S. stock market is one of the most suitable markets globally for HFT. It offers a wide range of stocks and derivatives, with a huge market size, high liquidity, high volatility, and very low trading fees—some brokers even offer zero-commission trading.

Why U.S. Stocks Are the Preferred Choice for HFT

Massive market size. The U.S. stock market attracts not only domestic investors but also global participants, making it extremely large. The daily trading volume of a single U.S. stock can equal the total trading volume of entire stock markets in other countries. For example, a well-known tech stock can have daily turnover of hundreds of billions of New Taiwan Dollars, far exceeding many countries’ daily averages, providing ample depth for HFT.

Relatively low trading costs. Since HFT profits from high trading frequency, costs are critical. If expected gains are 10-20%, a fee of 0.1-0.5% has limited impact. But with high-frequency trades earning only fractions of a percent per trade, costs become a major factor. Comparing Taiwan and U.S. fee structures: Taiwan’s transaction tax is 0.3% (0.15% for day trading), with a commission of 0.1425% (discounted by volume); U.S. transaction tax is only 0.00051%, with a 0% commission. The significant advantage in taxes and fees makes U.S. markets highly attractive for HFT.

Ample trading hours. HFT benefits from increased trading frequency, ideally operating 24/7. Taiwan’s market opens from 08:45 to 13:45, while the U.S. offers pre-market, regular, and after-hours trading, with global participation extending trading windows significantly. This makes U.S. markets more suitable for HFT.

Three Major HFT Strategies to Master

HFT typically employs three main strategies:

Market Making. The most common HFT approach, involving placing and canceling orders to create the illusion of active trading, attracting investors and pushing prices up or down, then quickly closing positions for profit. Similar to market-making after a stock listing, buying and selling to attract investor interest.

Arbitrage. Exploiting price differences of the same asset across different exchanges, different times, or between futures and spot markets. Traders buy low and sell high, expecting the price gap to narrow over time.

Trend Following. Following market trends to profit from the middle part of the trend. Traders often act around major news releases, such as earnings reports or significant announcements, buying after positive news or shorting during negative news to induce panic. Unlike market making, trend following amplifies existing movements.

Main Risks and Countermeasures in HFT

Engaging in HFT involves multiple risks that require careful management.

High psychological and discipline requirements. HFT demands rapid judgment of market trends and swift execution of stop-loss and take-profit orders. Hesitation or emotional decisions can cause huge losses. It is unsuitable for investors prone to panic or overtrading, who may keep adding funds hoping to recover losses, only to deepen their troubles.

Strict hardware requirements. HFT profits rely on capturing mispricings caused by time delays. Many traders compete for the same opportunities, requiring fast data reception. Inferior hardware or unstable internet connections can cause delays or disconnections, directly impacting execution. In this competitive field, hardware disadvantages mean inevitable failure.

Trading costs erode profits. High trading frequency leads to significant fees and taxes, which can eat into gains. Many Taiwanese HFT traders find that annual profits are less than what brokers or exchanges collect in fees, making low-cost platforms essential.

Overall, successful HFT requires experienced, disciplined, well-equipped, and cost-efficient investors. Proper preparation and planning are crucial to survive and profit in this competitive arena.

Practical Tips for HFT

HFT is not easy to master; it involves executing numerous trades in a short time to capture tiny price differences. If you want to try, keep in mind:

Choose markets with high liquidity. HFT needs a deep market for rapid trading. The largest U.S. stock market, with daily trading volumes in the billions, offers sufficient depth.

Strengthen capital management and discipline. Set strict stop-loss and take-profit points; disciplined capital management is fundamental. Also, select platforms with low transaction costs to maximize net gains.

When choosing a trading platform, evaluate trading costs, trading hours, leverage options, and available tools. The ideal platform offers competitive fees, extended trading hours, flexible leverage, and comprehensive market tools. Many investors start with demo accounts to test strategies before live trading.

HFT is a high-risk, high-reward field that requires a perfect combination of strategy, technology, psychology, and equipment. Only by fully understanding its mechanisms, assessing personal capabilities, and preparing thoroughly can one achieve consistent profits in this competitive trading style.