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The Impact of High Frequency Trading
- Ethan Qian-Tsuchida
- Aug 10
- 5 min read
If you’ve ever placed a trade, whether through a phone app, your retirement account, or a brokerage, there’s a good chance your order was handled, at least for a moment, by a high-speed algorithm. This is the world of High-Frequency Trading (HFT): a corner of finance where microseconds can make or break million-dollar decisions.
While the average investor is waiting by minutes or hours, HFT waits by milliseconds (a thousandth of a second) or microseconds (a thousandth of a millisecond). When trading at such speeds, more is a matter of seizing fleeting, infinitesimal windows of opportunity that only last for seconds, rather than speculating where a stock will be in seven days.
What Is High-Frequency Trading?
HFT is a type of algorithmic trading, meaning it uses computer programs that follow pre-set rules to place buy and sell orders. What makes HFT different from regular “algo trading” is speed and volume: trades are executed at a blistering pace, often thousands per second, using strategies designed to profit from:
Microscopic price discrepancies between related securities
Bid-ask spreads (the small gap between buying and selling prices)
Instant reactions to new market information
A common example is index arbitrage: imagine an ETF tracking the S&P 500 and the S&P 500 futures contract get slightly out of sync in price—maybe by just $0.01. An HFT algorithm can buy the cheaper one and sell the more expensive one, capturing the difference before human traders even notice.
How HFT Works Behind the Scenes
To achieve these speeds, HFT firms invest heavily in:
High-speed computers capable of processing massive amounts of market data in real time
Co-location services, paying exchanges to put their servers in the same building as the exchange’s servers to reduce signal travel time
Custom-built fiber optic and microwave networks to move data as quickly as possible between trading hubs (e.g., New York and Chicago)
This infrastructure is expensive, making HFT a game almost exclusively for large proprietary trading firms and major banks. Additionally, Ultra HFT, used by some trading firms, pays an additional exchange fee to gain access to see pending orders microseconds before the rest of the market does.
The Difference Between HFT and Low-Latency Trading
The two terms are often confused, but they’re not quite the same:
High-Frequency Trading (HFT) refers to specific strategies (and algorithms) that involve placing and canceling large numbers of orders extremely quickly, often profiting from very short-term price discrepancies.
Low-Latency Trading is about minimizing the time it takes to send, receive, and act on market data. It’s a broader term that applies to any trader (not just HFT firms) trying to reduce execution delays.
Think of it like this: low latency is the race car, and HFT is one style of racing that uses it. You can have low-latency trading without necessarily engaging in HFT strategies, but you can’t have HFT without low latency.
Benefits of HFT
Supporters of HFT argue it brings efficiency to markets by:
Reducing bid-ask spreads – Narrower spreads make it cheaper for all investors to buy and sell. For example, after Canadian regulators imposed fees in 2012 that discouraged HFT, studies found average bid-ask spreads rose by about 9%.
Increasing liquidity – By continuously posting buy and sell orders, HFT can make it easier for other traders to enter and exit positions without large price swings.
Improving price discovery – Prices adjust more quickly to new information when algorithms react instantly.
The Dark Side: Risks and Criticisms
Critics see HFT less as a public good and more as an arms race where the fastest player wins, often at the expense of slower investors.
The Flash Crash (May 6, 2010)
In the span of minutes, U.S. stock markets plunged by around $1 trillion in value, only to rebound almost as quickly. A single large futures trade triggered a cascade of selling by HFT algorithms, each reacting to the other in a feedback loop. At one point, shares of major companies briefly traded for a penny or $100,000 due to misfired algorithms. The event rattled confidence in market stability and led to the introduction of “circuit breakers” that pause HFT after large price swings.
Knight Capital Meltdown (August 1, 2012)
Knight Capital, then one of the largest U.S. trading firms, rolled out new software that malfunctioned, buying and selling $7 billion worth of stocks at irrational prices. Within 45 minutes, the firm had lost $460 million, about 40% of its value, and had to be rescued through emergency financing. A year later, Knight Capital merged with another HTF firm to form KCG Holdings.
Spoofing and Market Manipulation
Some traders program algorithms to place fake buy or sell orders they never intend to execute, creating a false sense of supply or demand. Once the market reacts, the orders are canceled, and the manipulator profits from the artificial movement. This practice, known as “spoofing,” is illegal but difficult to detect in real time.
Does HFT Hurt Everyday Investors?
Research is mixed. A U.S. Commodity Futures Trading Commission study found HFT firms made an average of $3.49 per contract trading with retail investors, more than they made trading with large institutions, suggesting that small investors may be at a disadvantage.
On the other hand, some studies find that the extra liquidity and narrower spreads created by HFT can net benefit retail traders, especially when trading in highly liquid stocks.
Regulation and the Road Ahead
Regulators have responded with measures like:
Circuit breakers to pause trading after sharp moves
Minimum resting times for orders to reduce hyperactive cancellations
Data surveillance systems like the SEC’s MIDAS to detect suspicious patterns
Globally, some countries (France, Italy) have imposed taxes on HFT activity, while others have welcomed it to boost market participation.
Still, the industry’s profitability is shrinking, from $22 billion in 2011 to around $6 billion in 2021, as competition, regulation, and technological parity erode the once-huge advantage of being fast.
The Bottom Line
High-Frequency Trading has transformed modern markets. It can make trading cheaper and more efficient, but it also magnifies risks when things go wrong, and those wrong moments can happen faster than anyone can react.
For everyday investors, HFT is invisible. Yet it’s woven into nearly every trade, quietly shaping prices and liquidity. Whether it’s ultimately a public service or a high-tech toll booth on the financial system remains one of the biggest open debates in modern finance.
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Written by Ethan Qian-Tsuchida
Newton South High School student
Interested in finance, economics, risk management, and teaching others about fun topics to make the world of finance and economics approachable.
Email - ethan.qiantsuchida@gmail.com
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