What is High-frequency trading (HFT) and how does it impact retail traders like me?

General
1

I have been hearing about how over 50% of the trading on Indian exchanges is by HFTs, can somebody explain
1). What does that mean?
2) What are the potential risks of High Frequency trading (HFT) or Algo trading?
3) How does it impact small retail traders like me?
4) Does traditional analysis ie, chart patterns, indicators still apply in the age of of HFT?
5) How do we protect ourselves from getting exploited by HFT?
6) What is your personal view about HFT?

2

1). What does that mean?

High frequency trading is a subset of algo trading, the difference between traditional algo’s vs HFT being the speed. HFT are algo’s/programs that use speed as an edge to execute trading strategies. Like investopedia says, HFT is algo trading on steroids. :slight_smile:
The idea is to make tiny profits but on large number of trades all executed automatically. HFT’s are mostly mispricing strategies.

So a strategy could be, if difference between Reliance on NSE and Reliance on BSE is more than 1 point, buy on one and sell on another. As soon as this difference reduces, exit it. If you can make 10 to 20 paise per trade, the goal is to try making thousands of similar trades a day.

Minimum requirement for HFT will be to have rack on the exchange colo. This way you can keep your trading server which is executing the strategy within exchange premises, giving it crucial millisecond speed advantage over being in another data center.

  1. What are the potential risks of High Frequency trading (HFT) or Algo trading?
    Risk is typically of a HFT strategy going bad. Firing orders continuously in a loop and potentially crashing/spiking up the markets. There have been incidents in other markets, but none so far in India. Regulators/exchanges have done a decent job to ensure checks and balances are in place.

  2. How does it impact small retail traders like me?
    HFT strategies are not what retail traders execute - cash future arbitrage, Put-call parity, etc. So in that sense retail traders don’t compete with HFT, on the contrary HFT brings in tons of liquidity which is good for retail traders.
    The only thing though is that when HFT’s are in play, there could be those sudden gush of volumes, spikes etc which may sometimes mislead traders to think is a real trend in price.

If you look at it holistically, it does a lot more good than bad for retail traders.

  1. Does traditional analysis ie, chart patterns, indicators still apply in the age of of HFT?
    Yes the same rules apply, but I don’t think retail traders should be trading every tick. Look at one min and above candles, so all the small noises that a HFT can create for a few seconds get smoothed out.

  2. How do we protect ourselves from getting exploited by HFT?
    Unlike in other developed markets, there are no dark pools, all retail orders hit the exchanges in India, and generally regulations are quite strict for anyone out there to exploit you. When people lose money trading, many tend to search for someone to blame, off late it seems to be HFT (it used to be operators in my time).

  3. What is your personal view about HFT?
    I personally think a retail trader has a huge edge over everyone else, the edge of being small. Don’t think a retail trader should be worried about HFT unless he is trying to trade some arbitrage/mispricing strategies like I mentioned earlier.

Capital markets require liquidity to ensure effective price discovery and reducing risk, HFT helps.

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