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High-Frequency Trading (HFT) Strategies

· 6 min read
Yellow DeFi


High-frequency trading (HFT) involves various specialized algorithms and trading strategies for high-speed trade execution, communication, and a large number of trades. The utilized strategies analyze multiple markets to detect a trend, get information faster and perform thousands of trades in a short period.

The basic principle for all HFT trading strategies remains the same: how fast the number of trades can occur in a specific period? Around this concept, many financial institutions, markets, and trading firms have developed specific HFT techniques to get an edge over the competition.

This article will discuss some of these latest and most potent strategies and how they maximize the gains for different financial entities.

Note: It is crucial to know that the strategies mentioned below vary with benefits, costs and not all of them are always available in specific geography because of state regulations and market conditions

Trading Strategies

There are many strategies that HFT companies employ for the fast turnaround of orders. Most of the strategies are implemented as algorithms that are programmed using high-performance languages, e.g. Golang.

The most commonly used HFT strategies are:

Statistical Arbitrage

Statistical Arbitrage is the most commonly used trading technique that provides a price advantage for the same asset on different exchanges. The HFT algorithm is trained to detect price consistency for an asset in different markets. Once the difference is detected, the algorithm takes a fraction of a second to execute a buy order on the less priced asset, which results in a source of profit for traders and firms during selling.

The chances for statistical arbitrage opportunities happen more frequently in crypto markets than the regular trading markets due to increased volatility; however, when these situations are identified, HFT practitioners are the first to find out and react before any slow traders.

News Based Trading

A news-based trading technique is simply a process of buying/selling trade orders based on the release of major news. In the traditional market, a trader who reacts first to news results in most profits but in the case of HFT, the algorithms have to be configured with news analysis methods to fire thousands of trades for maximum gains.

The news analysis methods provided to the HFT algorithm are capable of processing millions of stories in seconds so that the orders can be placed instantly in case of a response or a trigger. The analysis methods are also smart coded and can easily understand the type of news and even their sentiment (negative or positive).

While news-based trading does not provide any massive edge to any HFT practitioners due to the availability of information to everyone simultaneously, it makes the playing field even for all the HFT entities irrespective of their market capitalization.

Liquidity Provisioning

Another trading strategy by which HFT firms earn additional profits is by provisioning liquidity to exchanges. The HFT entities are paid rebates for the number of trade orders executed on different exchanges.

The HFT firms churn the most low-priced, high-volume stocks on a high frequency to keep the markets sufficiently liquid. For executing these large amounts of buy/sell orders through computing algorithms, several financial institutions create contracts with HFT firms to keep them financially stable over an investment period.

Also, all the HFT firms, irrespective of their scale, advertise them as liquidity providers for different markets; however, large public firms more effectively perform the service compared to smaller market-making firms due to their reliability and business connections with the exchange.

Infrastructure Colocation

As we discussed in the starting HFT industry is mostly about the frequency(how many orders in a specific amount of time). Even a slight amount of edge over your competition can result in large profits. To be the best in the industry, HFT entities try to be faster than each other by implementing the latest hardware and software infrastructure to increase their algorithmic computation and communication speeds.

Infrastructure is placed right beside the exchange’s servers(colocation) to provide minimal latency for computations. To reduce the latency even further, customers literally build straight tunnels that lay communication lines to connect to the primary exchange server directly. Many exchanges also offer colocation services over contract options to HFT firms to have the edge over the competition while utilizing their infrastructure to its best.

High-Frequency Trading (HFT) Company Types

Typically HFT companies are divided into three different types. A single firm can be all three.

  • Independent proprietary company: These firms execute trade orders for their profits. The money is invested by the company itself, not from external clients.
  • Broker-dealer company: These companies execute trade orders regularly for external customers through their HFT trading desks. This profit is usually separated between the clients and dealers. Examples are Virtu Financial and Tower Research Capital
  • Hedge funds: These firms execute trade orders based mainly on the Arbitrage trading strategy to profit from asset price fluctuations. Examples are Two Sigma Investments, Citadel Securities

HFT Strategies in the Crypto market

With HFT making up 80% of the volume in specific trade markets, it is becoming a significant cryptocurrency contributor. Various cryptocurrency exchanges are leveraging several HFT trading strategies with greater transparency to process trade information and orders.

A Cryptocurrency Trading Bot is implemented with pre-defined HFT strategies to allow exchange between crypto pairs. The strategies are built with transparency in mind to remain synchronous with decentralized networks.

Mass Adoption of HFT in the Future

While many traditional HFT companies explore decentralized assets, not many crypto exchanges can work efficiently with HFT strategies. There is a need for compatibility with blockchains, crypto pairs to reap the benefits of HFT.

Organizations can offer their solutions in the trial mode where firms can experiment with real-market data using virtual cryptocurrency coins. It helps the crypto HFT solutions improve in real-time and help build the right tools to employ HFT strategies with crypto markets in future years.

Want to Learn More About High-Frequency Trading?

This article covered all the major concepts and aspects relating to High-Frequency Trading (HFT) Strategies.

The following articles will discuss other advanced aspects like Ultra-High-Frequency Trading technology specifically designed for the crypto industry and more.

If you'd like to learn more about High-Frequency Trading, State Channels, and non-custodial Blockchain-agnostic software technologies, we will be adding more stories to Yellow DeFi Blog as we unfold the technology.

If you are researching the best software stack for your crypto exchange platform, we suggest taking a look at Yellow Layer-3 hybrid exchange software technology, combining the best features and performance of decentralized (DEX) and centralized (CEX) platforms.