Do you have high frequency trading software? Everybody loves the Flash. The show has been on for 7 seasons now with no signs of stopping. As children, we used to dream of having super powers. For a lot of us having Flash’s super speed was in the top 3 powers; if not at the top of the list. We’re still decades if not centuries away from replicating that kind of speed in our lives.
However, one place where it does occur on a day to day basis however is the stock market. What if I told you that there was a way to enter and exit a trade in less than a second? Or a way to even track what these speedsters are up to?
Where profits and losses are decided in milliseconds and microseconds. And just 1 millisecond faster can mean the difference between millions of dollars a day and absolutely crippling losses? Welcome to the world of High Frequency Trading also known as HFT.
Chart by TradingView.
Table of Contents
What Is High Frequency Trading Software?
High frequency trading software s something that can be extremely helpful to a trader. The faster things go with trading, the better. That goes for order fills, charts, scans, and trading computers. Unfortunately, we, as humans, aren’t as fast as HFT software would be.
Algorithm Trading
HFT is a form of algorithm trading with high speeds, high churn, and many successful transactions. It uses complex algorithms and computer tools to execute trades rapidly. High frequency trading software makes it occur within a matter of seconds. Or sometimes in a fraction of a second. Its origins can be traced back to the time telegraph, which was introduced in the early 1900s.
Traders standing in pits in one exchange would use high-speed telegraph services to management positions in other exchanges. Information flow moved very slowly in those times. And this provided a distinct advantage. Let’s try to understand this with an example.
How Do Oranges Compare to High Frequency Trading Software?
Let’s consider oranges and frozen concentrated orange futures. Oranges in the USA grow primarily in Florida during winter time. One winter, the temperatures soared, leading to a failure in an orange crop.
This caused the price of frozen concentrated orange futures to shoot up. This was due to reduced supply and constant demand. A trader operating in Florida would be aware of this crop failure.
However, those operating in California will not. They won’t know until news reaches them via newspaper or other channels.
In such a scenario, a Florida trader may use a high-speed telegraph network to take a position in a California exchange at a much lower price. Then benefit from the price rise once news reaches that area.
While the world has moved on to electronic trading and near instant execution, this scenario is still repeated via HFT today. But on a time frame beyond the comprehension of human beings. Hence high frequency trading software.
HFT in Modern Times
So what does high frequency trading software mean in modern times? Data moves at the speed of light, geared towards reducing the distances to beat the others to the exchange. So how legal HFT firms work is trying to front-run large orders by funds and institutions. They do this legally by observing market quotes and order flow.
The computer algorithm tracks order flow. And on seeing patterns of a large order flow, the front runs it with its orders first.
This is a highly simplified version of what happens. If you’re an HFT firm, you must get your orders before the fund enters the market.
What Is High Frequency Trading Algorithm?
High frequency trading software is an extension of algos like Flowtrade. It allows small trades to be filled at lightening fast speed like Flash. Trades being filled within milliseconds sounds like a great thing to me! Especially if you’ve had an experience with slow order fills.
Electric Signals
What does high frequency trading software mean with electric signals? Since all electric signals move at the same speed, the only edge one has is to reduce distance. As a result, one gets that small millisecond or microsecond advantage.
One way to do that is colocation. Colocation means placing your servers next to the exchange’s data servers for a fee. This allows HFT firms to access market information a fraction of a second earlier than the common public. This is enough time on the HFT timeframe to make a successful trade.
Another way of reducing distance is by laying down lease lines between exchange servers and data centers in as straight a line as possible.
In the excellent but hitherto unknown movie “The Hummingbird Project,” based on a real-life story, the lead character (played by Jesse Eisenberg) is working on a project that would lay down a fiber optic cable in a straight line from Kansas City exchange to New York Stock Exchange to reduce latency time to 16 milliseconds from 17 milliseconds.
They have to lay it in a straight line, which involves passing through swamps, mountains, rivers, residential and commercial properties, and millions of dollars of outlay to reduce one millisecond.
Is High Frequency Trading Software Legal?
Is high frequency trading software legal? Unfortunately, yes. And while it’s legal since the firms operate on publicly available data, this still seems unfair to the public leading to a hue and cry.
However, what has accelerated the hue and cry is unscrupulous behavior by some HFT firms spoiling the names of the rest. A lot of HFT firms work as market-making firms. Market making is where a maker provides bids (Buy orders) and offers (Sell orders). They make money from the spread, which is the difference between the buy and sell order prices.
However, the overzealous activity of some can lead to a flash crash along the lines of what occurred in 2010. In 2010, a futures trader Navinder Sarao triggered a crash of 1000 points in the Dow in 10 minutes. As a result, over one trillion dollars were evaporated, and some blue chip companies traded for less than a penny.
Till today that fear prevails. A fear that HFT firms will cause a flash crash. Another aspect practiced by HFT firms that is illegal is quote stuffing.
It involves entering and withdrawing many orders flooding the market and creating confusion, allowing HFT firms to profit.
High Frequency Trading Software and Volatility
High frequency trading software has also been instrumental in increasing the volatility of the markets. As a result, smooth trending markets are now choppy all along.
With the increasing volume and presence of HFT, about 50% of all trading in US markets is done by HFT firms. So while the volatility might be a bit different from what one is used to, one thing is for sure HFT firms are here to stay.
How can we, as retail traders, participate in this HFT? It is difficult, but we can sift the wheat from the chaff with effort and time.
So let’s first clear all doubts about the cost of true HFT software. It’s in hundreds of thousands of dollars to millions of dollars.
Most HFT firms have their proprietary software developed in-house along with necessary infrastructure like advanced computers, leased lines, data center fees, etc.
The software also requires constant maintenance and gradation as it becomes outdated or slower, or a newer, faster one comes into the market. But, on the other hand, codes are made leaner and more efficient, and every millisecond shaved off gives a distinct advantage.
The Cost
With all the expenses and costs factored in and with the potential of making millions of dollars every day, the question we, retail traders, must ask is why would anyone be selling you HFT software for a few hundred or few thousand dollars?
The answer is they’re not. Most of those claiming to be HFT software are fraudulent or not truly HFT but simple algorithms trading based on various indicators or strategies.
Most of these strategies will work in a backtest but not in live markets because if they worked, why would they sell it to you and diminish their edge?
For an HFT firm, the edge is in milliseconds and lies in executing the order first and ahead of others. If they start providing the same to retail traders, there will be crowding, and the edge of being the first is lost.
So take 99% of those selling HFT software with a pinch of salt and dig deeper into what they offer.
Providers
However, some genuine providers can resemble HFT systems, i.e., the Software will track bursts of activity, large market participants based on quote movements, market maker activity, dark pools, etc.
Flowtrade.com comes to mind as one of the top providers of algorithmic tracking software built by market makers and available for retail traders. The Software doesn’t execute your trades for you but lets you “see” what these programs are doing. Are they subtly buying when the price is dropping? Or selling the highs? There is a way to see beyond the price now.
Like all major software solutions today, this one is packaged as Software as a Solution (SaaS) and comes with a reasonable price tailored more towards traders who already know how to trade but want to trade better. There is also a free trial to see it in action.
Some track activity by HFT firms as well as by large market participants, and that includes HFT Alert on Twitter.
There are also firms like Lightspeed, info reaching, argo software engineering, blue rose technologies, etc., that will help design APIs and Software for you and rent out their infrastructure for your use and can be explored.
Conclusion
HFT, the name itself, invokes awe and admiration, a feeling of dealing with future technology. The ability to control things at the speed of light is what we all desire, and we can do just that, at least in our trading.
Who wouldn’t want to move in front of the big whales instead of behind them? HFT allows you to do just that. However, plenty of misleading providers are out there, and one had better tread carefully lest one get sucked in on the wrong provider.
As technology advances and prices come down, the playing field gets leveled, and it won’t be long before we, as retail traders rub shoulders with the institutions and giants in the field.
