High-Frequency Trading (HFT) is one concept that is known little to the average Joe trader, but one that causes the dramatic moves in the forex markets. Have you ever wondered why the market is moving so violently in a blink of an eye; tens or hundreds of pips? How is that possible? The answer lies with High-Frequency Trading (HFT).
Trading financial markets has changed over the past decades with the complete transformation of the financial industry. The internet was invented, and with that, access to foreign exchange became extremely easy. Online trading became a trend and online execution the norm.
Before that, robots were following traders, but this is not valid anymore. These days, traders are following robots, and these robots are the base of HFT. Such robots are in fact computers, and sometimes are also being called algos (a shortcut from algorithms).
These computers or algos, or programs, are instructed to buy or sell specific amounts based on different considerations; fundamental news, economic news, geopolitical news, levels being broken, etc. To have an idea about the size of the trading carried out by these algos, the number of trades per second is often exceeding thousands of trades.
If the regular retail trader is going for the 4th digit in a currency pair, that defines a pip, for the HFT industry the standard starts from the 8th digit and beyond. This is very accurate trading, and cannot be done without the use of technology.
Due to its immense liquidity, (five trillion dollars traded each trading day), it is not possible for human traders to cause such moves like the ones we’re seeing daily. Trading algorithms are responsible for these moves.
These trading algorithms or computer programs, or robots, are instructed to buy or sell a specific currency pair or even a currency across the board, based on the economic news that is being released daily. The economic news shows; the previous data, the forecasted data, while everyone waits for the new data.
The HFT algos are being instructed to buy or sell based on the actual released data and to interpret it based on the forecasted data. This is the reason why markets spike or dip aggressively on a news release, like the NFP (Non-Farm Payrolls) number or other economic releases.
Moreover, these algos are also able to read statements or texts, especially the ones released by central banks. The classical example comes from the Federal Reserve of the United States, which issues their FOMC (Federal Open Market Committee) Statement every six weeks.
This statement reflects the decisions the Fed took to address the current state of the economy. In fact, it is merely a document and trading robots are instructed to buy or sell a specific currency, in this case, the US dollar, based on specific wording that may or may not be in the FOMC Statement.
The same is valid for every speech a central banker is holding, like the semi-annual testimony of the Fed Chairman/Chairwoman, or the testimony of the European Central Bank President, given in front of the European Parliament. The examples are endless and all relate to HFT as the cause of abrupt price movements.
Recent examples nowadays are the SNB (Swiss National Bank) dropping the floor on the 1.20 peg on the EURCHF pair, which resulted in a sudden four thousand pip move, or the recent plunge in the GBP pairs as during the Asian session the pound collapsed across the board. This would not be possible if algos were not governing the forex markets, as such; similar moves are the result of robots trading in the same direction, levels being broken, and margin calls being triggered.
More about this subject to come in a different article here on ForexGator.com when we move on to more advanced topics.