Deep Dive into High-Frequency Trading: A Comprehensive Analysis from HFT to Market Impact

What is High-Frequency Trading?

High-Frequency Trading (HFT) originates from the English term High-Frequency Trading, abbreviated as HFT. Essentially, it is a strategy that uses computer systems to execute a large number of trades within milliseconds or even microseconds. The core features of this trading method are extremely fast entry and exit speeds, very short holding periods, with traders typically closing positions within seconds to minutes.

The evolution of high-frequency trading reflects the trajectory of technological advancement. In the early days, market participants mainly relied on manual responses for “high-speed trading,” but with the rapid development of computer technology, machines eventually surpassed human reaction speeds. Market Makers are a typical example of HFT participants—they use high-speed computers to generate quotes, manage risks, dynamically adjust prices, and continuously provide liquidity to the market.

The fundamental driving force behind the rise of HFT is the investment theory that “price spreads will eventually converge.” Traders utilize complex algorithms to discover arbitrage opportunities hidden across different markets and time points. For example, when Bitcoin’s price on a U.S. exchange exceeds that on a Japanese exchange, savvy traders will sell in the U.S. and buy in Japan, aiming to profit once prices balance out.

Hidden Tactics of High-Frequency Trading

Beyond traditional arbitrage, HFT traders also master more sophisticated psychological tactics. Some investors secretly build positions in certain assets and then place大量虚假订单 (large number of fake buy orders) on the market, creating a false market impression. This induces retail investors to believe that “big players” are bullish on the stock, prompting them to follow suit and buy. Once the stock price is pushed up to the expected level, HFT traders quickly cancel the fake orders and sell their holdings for profit. The cleverness of this strategy lies in the fact that high-frequency traders do not necessarily need actual transactions; they only need to manipulate market psychology to steer prices in the anticipated direction.

As the market share of HFT continues to expand, ordinary investors may find it difficult to participate directly. However, understanding its operational logic has become an essential lesson for modern investors.

The Multifaceted Impact of High-Frequency Trading on Market Ecology

Increased Liquidity

Although HFT is filled with orders that are difficult to distinguish between real and fake, a certain proportion of these orders do result in actual trades, significantly enhancing market liquidity. High trading volume makes stocks easier to buy and sell, attracting continuous new investors and creating a virtuous cycle.

Amplification of Market Volatility

HFT profits from market fluctuations, so its trading strategies tend to amplify the magnitude of stock market ups and downs. Since many HFT activities are automated by algorithms, even minor market movements can be magnified into signals of profit or loss, creating a “pump and dump” effect that further destabilizes the market.

Tax Revenue and Cost Consumption

The enormous trading volume generated by HFT brings substantial tax revenue, which is a key reason why governments often tolerate it. However, HFT participants also bear high trading costs due to the volume of transactions, and these costs ultimately translate into higher overall trading expenses for market participants.

The Legend of Quantitative Investing: Jim Simons and Renaissance Technologies

When discussing successful examples of HFT, mathematician Jim Simons is an unavoidable figure. Simons founded Renaissance Technologies, a legendary quantitative hedge fund known for its Medallion Fund.

This fund 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 as a code-breaking expert in intelligence fields, then turned to academia as a geometry master, and finally applied his mathematical genius to investing.

Simons’ early strategy involved using complex mathematical and statistical models to capture tiny market price fluctuations for high-frequency trading. Over time, Renaissance Technologies grew into a large team of hundreds of experts developing sophisticated algorithms containing over 10 million lines of code, enabling nearly fully automated, efficient trading operations.

By the end of 2019, the firm managed assets worth approximately $130.1 billion. During the volatile global markets of 2020, this quantitative hedge fund still achieved a 39% growth, with a net profit of 24% after management fees, further demonstrating the formidable power of HFT strategies.

What Markets Are Suitable for High-Frequency Trading?

Engaging in HFT requires executing hundreds or even thousands of orders frequently, demanding very high standards from the trading environment. Each trade incurs transaction fees and taxes, which can significantly eat into profits. Therefore, markets suitable for HFT should have the following two key features:

Large Market Size and Abundant Liquidity

HFT requires rapid entry and exit within a short period. If the market is too small or lacks sufficient liquidity, it directly affects execution speed and price stability, leading to slippage or failed trades. Additionally, ample volatility and variation are necessary to continuously discover opportunities and profit margins. The larger the market size, the stronger the liquidity and volatility, the more suitable it is for HFT.

Low Transaction Taxes and Fees

Due to the high frequency of trades, transaction costs and taxes constitute a significant portion of profits. If platform fees are too high, they can wipe out most of the gains or even cause overall losses. Therefore, markets with lower costs are more favorable for HFT.

Based on these considerations, the U.S. stock market has become one of the most suitable platforms globally for HFT, offering a rich selection of stocks and derivatives, a large market scale, strong liquidity, high volatility, and extremely low transaction costs.

Why Has the U.S. Stock Market Become the Preferred Arena for HFT?

Global Market Size and Trading Depth

The U.S. stock market attracts investors from around the world, resulting in an enormous market size. The daily trading volume of a popular U.S. stock often exceeds the total of many countries’ entire stock markets. For example, on September 23, Tesla’s daily trading volume reached $176.36 billion (about NT$5.59 trillion), while the entire Taiwan stock market’s daily turnover was only around NT$200 billion. This massive trading depth provides ample “hunting grounds” for HFT.

Cost Advantage

HFT amplifies returns by increasing trading frequency, so cost concerns are far more critical than for ordinary investors. If the target return is 10-20%, transaction fees of 0.1%-0.5% have a minor impact. However, HFT profits per trade are often only a few tenths of a percent, making transaction costs a large proportion of overall gains.

Comparing fee structures between Taiwan and the U.S.:

U.S. transaction taxes and fees are significantly lower than Taiwan’s, providing a clear advantage for high-frequency traders relying on high turnover.

Sufficient Trading Hours

HFT aims to maximize profits through high trading frequency, ideally operating around the clock. Taiwan’s stock trading hours are from 8:45 AM to 1:45 PM, whereas the U.S. market offers pre-market, regular, and after-hours trading. Participants across different time zones can engage in U.S. stock trading during their working hours, greatly extending effective trading time and aligning well with HFT logic.

Practical Risks Faced by High-Frequency Trading

Psychological Discipline and Mental Toughness

HFT demands excellent psychological qualities and strict discipline. Traders must make instant judgments and execute stop-loss and take-profit orders swiftly. Hesitation or emotional decision-making can lead to huge losses. HFT is not suitable for investors prone to “overtrading” or “chasing losses,” who tend to keep adding funds in an attempt to recover, ultimately sinking deeper.

Hardware and Network Infrastructure

HFT essentially profits from “mispricing” caused by time delays and other factors. Due to intense competition, leading hardware and stable network connections are critical for success. If hardware is outdated or network connections are unstable, delays or disconnections can cause missed opportunities. In this highly competitive field, lagging behind in equipment means being eliminated.

Long-term Erosion from Trading Costs

The high frequency of trades means that transaction fees and taxes continuously eat into profits. Many Taiwanese HFT traders find that their annual gains are less than the fees charged by brokers and exchanges, highlighting the importance of choosing low-cost trading platforms.

Overall, successful HFT requires experienced, psychologically stable, technologically advanced, and cost-controlled professional investors. If you decide to venture into this field, thorough preparation and meticulous planning are essential.

Main Strategies of High-Frequency Trading

Market Making

This is the most common HFT method. Traders place and cancel orders to create a false impression of active trading in a stock, attracting investors and pushing prices up or down. The HFT trader then quickly closes positions to realize profits. The logic is similar to market making during IPOs, where buying and selling are used to guide investor participation.

Arbitrage Strategies

Arbitrage exploits price differences of the same asset across different exchanges, different times, or between futures and spot markets. Traders anticipate these spreads will converge over time and buy low and sell high or sell high and buy low accordingly.

Trend Following

This strategy focuses on following market trends, aiming to profit from the middle phase of a trend. Traders often act when companies release major news—such as buying heavily after earnings reports to push prices up, or shorting during negative news to trigger market panic. Compared to market making, trend following is more about riding the wave.

Summary: Core Recommendations for HFT

HFT is not a simple endeavor. It requires executing a large number of trades within extremely short timeframes to extract profits from tiny price fluctuations. If you wish to engage, keep in mind the following points:

First, choose markets with high liquidity. HFT demands deep market depth, making the U.S. stock market the top choice, with daily trading volumes in the billions.

Second, HFT must be built on strict risk management. Setting reasonable stop-loss and take-profit points is crucial, and there must be no room for complacency. Also, selecting a trading platform with low fees is essential to effectively enhance returns.

In summary, successful HFT relies on deep market understanding, solid technical preparation, strong psychological resilience, and extreme cost control. Only with these foundations in place can one survive and profit in the competitive arena of high-frequency trading.