HFT strategy guide – what is it and how to use it?

Forex traders have access to various different trading strategies to achieve their trading objectives. There are multiple ways to make money in the market.

You’ll find traders that are scalping, position trading, intraday or swing trading. Some place orders manually, while others use algorithms to automate their trading.

HFT trading strategy in FX heavily relies on technical indicators and trades are executed on short timeframes.

Understanding how HFT works can be beneficial for every trader. Even if you are not planning to use robots to execute hundreds of trades daily, you’ll get a clear picture of how markets are influenced by algorithms.

Core features of HFT strategy

• HFT strategy for trading FX pairs involves making thousands of automated trades during a trading session
• Successful high-frequency trading requires liquidity, tight spreads and very low slippage
• The best HFT trading strategy requires high-end trading software and is done by professionals
• Traders use high speed internet to maximize their chances when using HFT strategies
• No orders are left open past the end of a trading session
• Profit margins are razor-thin, which leads to thousands of orders being placed in a matter of minutes
• Human input in HFT is often limited to customizing trading algorithms

How does the HFT strategy work in forex?

High-frequency trading has seen a rapid rise among trading communities during the past few decades. Powerful hardware and software solutions allow professional traders to execute thousands of trades across multiple markets for incremental profits. The profit margins are incredibly small and often limited to a single pip per trade. However, if done successfully, these tiny profits can add up to substantial income in the long run, thus, being a net positive for those who practice it.

The trading hardware is usually located as close to trading centers as possible to ensure instant data transmission and order execution. HFT is especially popular among stocks and forex traders, and such trading activity boosts liquidity on the market. Every HFT strategy Forex traders use requires high-end software and superfast internet connection.

Purpose of HFT strategies

The core purpose of HFT is to use proprietary technology to beat the market. HFT systems use minimal profit margins and execute trades in milliseconds. Such requirements make high-frequency trading inaccessible to most retail traders, as it is associated with high capital requirements and regulatory scrutiny. HFT strategies focus on different indicators and use customizable trading algorithms to identify opportunities within milliseconds. The reliability and profitability of an HFT strategy can be determined by how fast it can cover initial capital contributions and what average monthly gains it can generate. Often, institutions use artificial intelligence to develop HFT strategies. There are algorithms that predict how other algorithms will react to market changes. HFT trading is highly competitive.

Pair trading strategy

Pair trading is one of the oldest high frequency trading strategies available to traders. The key focus of pair trading is to find market-neutral opportunities by placing long and short positions on correlated currency pairs. The difficulty of this strategy is the relatively high degree of correlation necessary for effective trading. Pairs with over 80% correlation can be hard to identify. The difference between the two long and short positions should give way to very tight profits, which HF traders can gain by placing hundreds of such orders.

Iceberg orders

Iceberg orders are large orders divided into many small parts. Iceberg and sniffer strategies are used by experienced high-frequency traders to identify other traders who are using automated trading. The order type is usually used by institutional traders who wish to buy large quantities of instruments but do not want to affect the demand on the market. Therefore, they resort to breaking up their orders into much smaller ones and place them after small-time delays. Sniffers work to identify such iceberg trades and take advantage of the price movements caused by them. Both iceberg and sniffer strategies are used by professional traders with years of experience, as identifying such opportunities requires considerable amounts of research and market knowledge.

Flash orders

Flash trading is the most controversial entry on this list and has largely been prohibited across the trading community. Flash traders get access to order books before they hit the market. This happens in milliseconds with minimal latency – creating an unfair advantage for algorithmic traders. The Flash Crash of 2010 was one of the reasons why a large portion of traders abandoned the strategy, but some still use it. Proponents of this strategy argue that it increases liquidity on secondary markets, while those who oppose it argue that it gives unfair advantages to algorithmic traders.

High-frequency scalping

Scalping is one of the most widely used day trading strategies in forex. While typical scalping strategies might not be done within a matter of seconds, high-frequency methods powered by algorithms can place thousands upon thousands of trades in a session. Technical indicators point to long and short positions and the algorithm executes them – netting minimal profits per trade. Scalping is the most straightforward version of high-frequency trading and delegates the technical aspect entirely to software, which can reliably identify patterns on a chart and place trades at speeds impossible for humans.

Criticisms

Many critics of high-frequency trading argue that the strategy has no real tangible benefit on the market and that it is a form of market manipulation through sheer trading volume. Some have gone as far as to demand the banning of HFT altogether.

Another source of criticism cites that large institutions take advantage of miniscule opportunities on the market with no real input – taking away the opportunities from retail traders.

The ‘Flash Crash’ of 2010 is one of the most frequently cited shortcomings of high-frequency trading. On May 6, the Dow Jones Industrial Average dropped 10% in a matter of minutes, before returning to its original price. Every HFT strategy for Forex trading uses some form of algorithms. Robots do not have emotions and can lead to massive overselling and crashing the markets.

Regulation

Due to the criticisms and market manipulation attempts from traders, HFT is regulated in most countries. The SEC and ESMA have rules in place that need to be followed to have access to HFT systems.

Regular reviews and audits are required to detect any attempts at market manipulation or foul play. It is estimated that around 60% of transactions on US capital markets are done through HFT software.

Pros and cons of HFT

High-frequency trading has been a somewhat controversial topic over the years and comes with its unique sets of advantages and disadvantages.

Pros

• Traders require no intermediaries between them and the market
• Increases liquidity on the market
• High liquidity reduces volatility throughout the trading session
• High liquidity leads to tighter spreads, which is a net positive for traders

Cons

• Limited to institutional traders with vast sums of cash and proprietary technology at their disposal
• May lead to mispricing of instruments, which can be damaging to other traders
• The execution speed gives an unfair advantage to software
• Can amplify volatility at times
• Could be used for market manipulation
• Orders are based on technical analysis, with little regard for fundamentals

Example of HFT strategy in forex

Now let’s take a look at the HFT strategy example. HFT in Forex can be somewhat more constrained than HFT in stock trading. The forex market does not benefit from the same degree of liquidity on all hours, and the periods when New York and London sessions overlap are the most appropriate time to use HFT in forex. To conduct HFT reliably and with minimal slippage, very tight spreads are necessary. This is why most HF traders stick with major pairs.

For example, an HFT operation trading the GBP/USD pair can place thousands of trades for profits as low as a single pip. However, using such a strategy with reliable profits can generate thousands of pips of profit on each session – essentially covering the fixed software and hardware costs for HF traders.

FAQs on HFT strategy

How does HFT strategy make money?

HFT strategies make money by using sophisticated software solutions to place thousands of trades that execute within milliseconds for incremental profits. Such profits can add up substantially over longer periods of time.

How much do HFT strategy traders earn?

Most traders that use HFT strategies do not do so with individual accounts. HFT first employs professional traders to construct algorithms and monitor the performance of HFT systems for trading to run smoothly. On average, HF traders can expect to make north of $100,000 per year.

How much money do you need to implement HFT strategy?

Setting up a high-frequency trading operation for FX is relatively inexpensive compared to HF stock trading. Traders can use the MetaTrader VPS to get the lowest possible latency. The initial costs of high-frequency forex trading are not very high and can be done via virtual servers subscriptions.