High-Frequency Trading Depth Analysis: From Strategy Logic to Market Selection

What is High-Frequency Trading?

High-Frequency Trading (HFT) is an investment strategy that uses computer algorithms to execute a large number of trades within milliseconds or even microseconds. This trading method originates from advances in computer technology, enabling institutional investors to enter and exit the market at speeds impossible for humans.

The core features of high-frequency trading are extremely fast trading speeds and very short holding periods. Market Makers are typical representatives of HFT—they rapidly generate quotes, manage risks, dynamically adjust prices through high-speed computers, and provide continuous liquidity to the market.

The history of high-frequency trading dates back to the early days of the computer era. Early investors had to place orders in person at exchanges, later they could trade remotely via telephone, and only after the advent of computers did rapid information analysis and hidden arbitrage opportunities become truly feasible. Many institutional entities profit from HFT based on the principle that “price spreads will eventually converge.”

For example, if the Bitcoin price on a US exchange is higher than on a Japanese exchange, traders can sell in the US and buy in Japan, and once prices balance, complete the arbitrage.

The Psychological Tactics of High-Frequency Trading

Beyond traditional arbitrage, HFT also involves market psychology manipulation. Some investors will first establish positions, then place大量虚拟委托单 (large virtual orders), creating the illusion that a certain asset is “favored by big players,” attracting retail investors to follow and buy, pushing prices higher. Subsequently, traders quickly cancel orders and sell their holdings to profit from the spread.

The key point is: HFT does not necessarily require real transactions; it can also manipulate stock prices through market psychology. These operations are increasingly contributing to the total market volume, so even investors not engaged in HFT should understand how it works.

The Threefold Impact of High-Frequency Trading on the Market

Increase Market Liquidity

Although involving虚拟委托单 (virtual orders), HFT still accounts for a certain proportion of actual transactions, thereby increasing market liquidity. This makes assets easier to buy and sell, and higher trading volume can attract more retail investors.

Worsen Market Volatility

Since HFT traders profit from market fluctuations, their strategies tend to amplify price swings. Many HFT programs automatically trigger during volatile markets, further magnifying gains and losses, creating an “amplification effect.”

High Trading Costs

HFT results in enormous trading costs due to the large volume of transactions. Governments have not banned HFT; instead, they collect substantial tax revenue from it, making them invisible beneficiaries.

The Legend of HFT: Jim Simons and Quantitative Investing

When discussing HFT, one cannot ignore mathematician Jim Simons. Born in 1938, Simons earned a PhD in mathematics at age 23, worked as a code-breaking expert, then shifted to academia to study geometry, eventually applying his mathematical talents to investing.

He founded Renaissance Technologies and its flagship Medallion Fund, which from 1989 to 2006 achieved an astonishing average annual return of 38.5%, far surpassing traditional hedge funds. Simons is hailed as the “King of Quantitative Investing.”

Today, Renaissance Technologies employs hundreds of experts, utilizing complex algorithms to execute over 10 million lines of code for automated trading, with minimal human intervention. By the end of 2019, the firm managed assets worth $130.1 billion. Even amid the intense market volatility of 2020, the fund still grew by 39%, net of fees, earning 24%.

What Markets Are Suitable for High-Frequency Trading?

To engage in high-frequency trading involving hundreds or thousands of trades, one must carefully select targets, as each trade incurs transaction fees and taxes. Markets suitable for HFT generally have two key features:

Market Size and Liquidity

HFT requires rapid entry and exit within short periods. If the market is too small or illiquid, it hampers execution speed and price accuracy, leading to slippage or failed trades. Sufficient volatility is also necessary to generate profit opportunities. Therefore, larger markets with high liquidity and volatility are more suitable for HFT.

Low Taxes and Trading Fees

Due to the high volume of trades, transaction costs and taxes can significantly eat into profits. Excessively high fees can erode most gains or cause losses. Markets with lower fees and taxes are more suitable for this strategy.

Based on these criteria, the US stock market is one of the most suitable markets worldwide for high-frequency trading. The US stock market offers a wide variety of stocks, comprehensive derivatives, enormous market size, high liquidity, and high volatility, with extremely low fees—some brokers even offer zero-cost trading.

Why is the US Stock Market the Best for HFT?

Massive Market Volume

The US stock market attracts investors globally, with an enormous trading volume. The daily trading volume of a single US stock often exceeds the total daily turnover of some countries’ entire stock markets. For example, on September 23, Tesla’s single-day trading volume reached $17.636 billion (about NT$559 billion), while Taiwan stocks’ total daily volume was only about NT$200 billion—a huge gap.

Extremely Low Trading Costs

HFT relies on high trading frequency to generate profits, making it highly sensitive to transaction costs. If the expected profit per trade is 10%-20%, a fee of 0.1%-0.5% has limited impact; but for HFT, where profit per trade may only be a few basis points, costs can significantly eat into returns.

Comparison of tax and fee structures:

US markets’ transaction taxes and fees are far lower than Taiwan’s, providing a decisive advantage for HFT.

Sufficient Trading Hours

HFT requires maximizing trading frequency to amplify profits, ideally trading 24 hours a day. Taiwan’s stock market trading hours are limited to 08:45-13:45, whereas the US offers pre-market, regular, and after-hours trading, allowing investors across different time zones to participate, making the US market more suitable for HFT.

Risks and Challenges of High-Frequency Trading

Psychological Resilience and Discipline

HFT demands excellent mental resilience and strict discipline. Traders must quickly assess market trends, execute stop-loss and take-profit orders swiftly; hesitation or emotional decisions can lead to significant losses. It is not suitable for investors with a “dipping in and out” mentality, who might keep adding funds to recover losses, risking deeper trouble.

Hardware and Technical Requirements

HFT essentially involves capturing “mispricing” opportunities, with many participants competing for the same profit space. Advanced hardware and stable network connections are essential for rapid data reception; delays or disconnections put traders at a disadvantage. HFT is a highly competitive field; inadequate equipment means elimination.

Hidden Costs of Transaction Fees

Due to extremely high trading frequency, transaction fees and taxes can erode large portions of profits. Many investors find that their annual gains are less than the total fees paid, making low-cost platforms crucial. HFT is suitable for experienced investors with strong psychological resilience, advanced equipment, and tight cost control.

The Three Main Strategies of High-Frequency Trading

Market Making Strategy

The most common HFT approach. By placing and canceling orders, traders create a false impression of active trading, attracting other investors, pushing prices up or down, then quickly closing positions for profit—similar to market making during IPOs.

Arbitrage Strategy

Exploiting price differences of the same asset across different exchanges, different time periods, or between futures and spot markets to buy low and sell high or vice versa. Traders anticipate these spreads will converge, executing arbitrage trades accordingly.

Trend Following Strategy

Following market trends to profit from mid-trend movements. Traders often act around major company news—buying heavily after positive news to push prices up, or shorting during negative news to induce panic. Unlike hype-building, trend following is about amplifying existing momentum.

Summary

HFT is not easy; it requires executing numerous trades within a short timeframe to capture tiny price differences. To attempt this strategy, note:

First, choose markets with sufficient liquidity. HFT demands deep market capacity; the US stock market, as the largest global stock market with daily trading volume in the hundreds of millions of trades, is most suitable.

Second, manage turnover rate carefully and strictly enforce stop-loss and take-profit rules. Selecting low-fee trading platforms is crucial to enhance profitability.

HFT involves risks and opportunities. Investors should prepare thoroughly and develop detailed plans before entering this highly competitive market to survive and profit.