High-Frequency Trading Strategy And Statistics – HFT Backtest

The high-frequency trading strategy is a method of trading that uses powerful computer programs to conduct a large number of trades in fractions of a second. It is a type of algorithmic trading strategy that uses high speeds, high turnover rates, and high order-to-trade ratios to take advantage of small, short-lived profitable opportunities in the markets.

The emergence of the internet gave rise to electronic trading. With the advancement in supercomputers and electronic communication, high-frequency trading has become commonplace in today’s financial markets. But what exactly is a high-frequency trading strategy?

In this post, we take a look at high-frequency trading strategy and explain what it is. We end the article by discussing high-frequency backtesting and if retail traders actually can be successful at HFT trading.

Table of contents:

What is a high-frequency trading strategy?

High-frequency trading (HFT) is a method of trading that uses powerful computer programs to conduct a large number of trades in fractions of a second. That is, supercomputers are programmed to use complex algorithms to analyze multiple markets, identify profitable opportunities, and execute trades in fractions of a second.

HFT, therefore, can be considered a type of algorithmic trading strategy characterized by high speeds, high turnover rates, and high order-to-trade ratios that leverages high-frequency financial data and electronic trading tools.

It uses sophisticated technological tools and computer algorithms to rapidly trade securities. In fact, there is no single definition of HFT; however, its key attributes include highly sophisticated algorithms, the closeness of the server to the exchange’s server (colocation), and very short-term trading durations.

The strategy is mostly employed by institutional traders who have the necessary resources to use high-powered computers to analyze the markets and identify trends in a fraction of a second. The super-fast computers can analyze the markets and spot minute and short-lived profitable opportunities before they become clear to other traders watching the markets.

What is the percentage of high-frequency trading in the stock market?

According to various sources, the percentage of high-frequency trading (HFT) in the stock market varies by region and asset class. In the US equity markets, HFT represents about 50% of trading volume2 3. In European equity markets, its share is estimated to be between 24% and 43% of trading volume, and about 58% to 76% of orders2. In 2016, HFT on average initiated 10–40% of trading volume in equities, and 10–15% of volume in foreign exchange1. It is important to note that these percentages may change over time and may vary depending on the specific market conditions.

Is high-frequency trading profitable?

Yes, high-frequency trading is very profitable for the few trading firms with the right equipment. The trading opportunities that HFT strategies target are often short-lived, so speed is of utmost importance. Typically, the traders with the fastest execution speeds are more profitable than traders with slower execution speeds.

Apart from speed, HFT is also characterized by high turnover rates and order-to-trade ratios. Since the profits per trade are usually very small — pennies per share per trade — they magnify their profits by trading huge volumes at a time and making multiple trades (thousands of trades) in a day.

In fact, HFT strategies are structured to make a profit off the smallest changes in prices. By making such trades over and over, which is why they are called “high-frequency trading” anyway, they theoretically generate huge profits, but a fraction of a cent at a time.

High-frequency trading software

High-frequency trading requires complex electronic trading systems and computer algorithms. There are different software available for HFT, but what HFT traders consider is the features of the software. One key feature is the latency time — the time that elapses from the moment a signal is sent to its receipt — which determines the speed of order execution. High-frequency traders go for software with the lowest latency so as to gain a competitive edge in trading.

Other features high-frequency traders look for in HFT software include:

Ability to trade multiple markets: Access to global equity markets, futures, options, and FX.
Risk control: Risk assessment of every order request and ensures compliance with pre-configured risk management parameters.
Brokerage access: Ability to the multiple brokers, exchanges, and electronic communication networks (ECNs).
Centralized monitoring and control: It should have servers that can be distributed across various geographical locations of the exchange servers, but all strategy performance monitoring and control functions can be performed from a centralized remote location.
Execution speed: Ability to execute, at least, tens of thousands of orders per second per single FIX connection.
Low latency: Sub-millisecond for a roundtrip.
Distributed and scalable: The ability to scale and increase efficiency by having different strategies run concurrently. Can have multiple components deployed across multiple servers at various execution venues.

High-frequency trading strategy example

There are different strategies and methods high-frequency traders employ in their trading, but whatever strategy is programmed into the HFT software. So, let’s say an HFT system that monitors the market for index arbitrage opportunit