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High-Frequency Trading in Forex — Good or Evil?

High-frequency trading (HFT) seems to be a hot topic both in the financial trading community and among common laymen who are concerned with the consequences of such trading practice. Italy passing a tax on HFT transactions and the calls from the general public to restrict HFT signal about a rather controversial situation with the subject matter.

High-frequency trading can be defined as automated (algorithmic) trading with extremely fast execution (milliseconds or even microseconds), very short holding periods, very small position sizes and very small targeted profit per trade. Unfortunately, there is little accurate information available on high-frequency trading in general, and even less of it exists in foreign exchange market. I recommend Wikipedia article on HFT to get the basic information on the concept with a strong bias towards equities. At the same time, considering the intrinsic differences between stocks markets and Forex, it is important to note that it is not a good practice to draw conclusions from HFT in stocks to HFT in currency trading. BIS report on HFT is the best (albeit slightly outdated) introduction to the practice among Forex market participants.

There are several misconceptions about HFT that I would like to point out:

  • HFT is intrinsically illegal. Currently, there is no ruling that would call high-frequency trading illegal, and it does not necessarily involve any illegal activities (like insider trading, for example).
  • HF traders are able to use a special kind of orders that may cancel themselves when a counter-party accepts that order. HFT has no access to such special orders, but they can imitate similar behavior using a large number of small orders and fast reaction to actions of other traders.
  • Only big hedge funds and investment banks profit from HFT. In fact, the contrary is true — HFT is mostly practiced by rather small (compared to big financial institutions) specialized companies.
  • HFT is risk-free. It is considered to be very risky by both market professionals and researchers. The reason for the high level of risk is mostly in the fact that HF traders have to keep a constant flow and monitoring of a large number of orders. Any infrastructural disruption can be detrimental to HFT operation.

Here are some facts about HFT in in relation to Forex trading:

  • Co-location is very important to achieve competitive speeds.
  • HFT (like the whole Forex market) is self-regulated. It is regulated by company's own risk management, broker's monitoring and the rules of the applied trading platform.
  • Triangular (and other) arbitrage is possible with HFT.
  • HFT can learn about price change at the liquidity provider faster than some big market maker using the same liquidity provider, so HFT can try to exploit this knowledge before the market maker updates its price.
  • The majority (but not all!) of HFT strategies are designed to benefit from high liquidity and low volatility, which is considered to be beneficial to the whole market.
  • Only small number of banks practice HFT in their proprietary trading, but they do not consider HFT as an important part of their business.
  • HFT participants prefer multi-bank ECNs or such global platforms as Reuters and EBS for the abundance of trading opportunities in their environments.
  • Currenex — is considered a good platform for HFT as it does not impose such requirements as minimum quote life or minimum fill ratios.
  • Since Forex is a fragmented marketplace, HFT firms are useful in spreading liquidity around the system and between different ECNs, platforms.
  • Total share of daily FX volume generated by high-frequency traders is considered to be less than 25% of all spot FX market turnover ($7.5 trillion per day as of April 2022).

If there is something specific you would like to say about high-frequency trading in Forex or you have some questions, you can join our forum for a discussion.