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What is High Frequency Finance?

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  • Written By: Bradley James
  • Edited By: Kathryn Hulick
  • Last Modified Date: 20 January 2020
  • Copyright Protected:
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    Conjecture Corporation
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High frequency finance, also known as high frequency trading, is the use of complex algorithms to analyze market conditions. The goal is to make a profit by being the first to capitalize on small anomalies in market trends. In order to do this, traders use complex computer programs to execute a high volume of trades in a short period of time. The faster a trader can execute a trade, the more profitable he or she will be. High frequency finance is the computational math behind the complex algorithm which tells the computer program how to execute orders.

In order to make a profit in high frequency finance the trader must be able to make a large number of trades. After the collapse of Lehman Brothers in 2008, exchange houses such as the New York Stock Exchange (NYSE) introduced a new role into the marketplace. The role is solely responsible for increasing liquidity. The name of the role is supplemental liquidity provider (SLP) and most any company can be an SLP.

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Liquidity is defined as the ease with which a particular security can be traded in the market. Liquidity in the market is measured by looking at the spread between the bid and ask price for a security. The more buyers and sellers there are in the market, the better the liquidity is in the market, and the tighter the difference between the bid and ask price. In other words, a tighter spread between the bid and ask price means there are more trades occurring on that particular exchange.

Exchanges make money from the number of transactions made, not on the dollar amount traded. As a result, it is in the NYSEs best interest to promote liquidity in the market. Consequently, SLPs are paid a fee for adding competition and liquidity into the market. The fee is only a fraction of a cent, however, it in not unusual for an SLP to make millions of transactions per day. The higher the frequency of transactions, the more profit the SLP makes.

These same high frequency finance systems can be used to spot trends and potential market anomalies. When automated, these systems provide institutional and large scale buyers with an edge. Those high frequency finance systems which spot the anomalies and act on them first stand to profit the most.

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