Traders employ different strategies and patterns to make money from the crypto market. The choice of strategy is usually the one with which they are most comfortable. It is best to consider different short-term and long-term strategies to determine the right style for you. High-frequency trading is one of the short-term trading styles that has worked in different financial markets—but is it the right crypto trading strategy for you?
What Is Crypto High-Frequency Trading?
High-frequency trading (HFT) is a trading style that uses algorithms to analyze and execute a large number of trades in quick succession, usually within seconds. The goal is to profit from little price gaps in the market. The traders gain a little profit every time they trade and hope to get significant profit over time.
The speed requirement for HFT is beyond what humans can meet up with, as you would need to open and close many trades within seconds to get short-term gains. For this, experts prefer using algorithmic technologies to track and execute signals. When trading, algorithms with faster speeds have advantages over slower ones.
The trading style has been used in the stock and forex markets over the years and was recently extended to the crypto market.
How Crypto High-Frequency Trading Works
The trading method speculates on short-term price movements, trying to detect market conditions that are not visible to the human eyes or that humans are not fast enough to react to. The algorithms control the schedule of sending market orders as they read real-time market data and information to identify favorable opportunities.
HFT trading can be used in arbitrage trading, bid-ask trading, and other short-term trading styles that require similar algorithmic requirements.
Arbitrage Opportunities
Prices of cryptocurrencies have slight differences across various exchanges, creating opportunities for arbitrage trading. Arbitrage trading is a method that tries to profit from the little price differences in different exchanges or markets within the same exchange.
You will have to buy at a low price from one exchange or market and sell at a higher price in another exchange or market. This long process has to be made quickly, almost simultaneously, before the market price changes. Arbitrage trading opportunities can sometimes result from news activities and price speculations.
Bid and Ask Spread Difference
This strategy can also be called the market-making strategy. Using this method, traders try to make money from the difference between the bid and ask prices, which is the spread. They execute buy and sell orders at the same time in a bid to profit from the spread. They do this constantly, aiming to get a small profit from each trade until the overall profit becomes substantial.
For example, let's say they buy ether at $1,300, the ask price, and sell it at $1,303, which is the bid price. The spread, in this case, is only $3, and the money made from that trade comes from the spread.
What the algorithm does here is to try to make a little profit from the little spread within a second or a few seconds. Of course, the spread is small and almost insignificant, but it doesn't matter much because HFT traders trade in large volumes.
High-frequency trading is a short-term trading strategy and only requires speculating on prices based on short-term movement and analytics. It is close to a scalping trading strategy or could be regarded as a fast-paced scalping strategy using powerful computers to secure profits in seconds or even less than a second. HFT surely gives institutional traders and big organizations a hedge in crypto trading as it seeks to be the first to profit from a new trend.
5 Pros and Cons of High-Frequency Trading
Below are some advantages and disadvantages of crypto HFT.
1. Pro: Trading Speed and Automation
You won't have to open and close the trades yourself. Instead, the whole process is automated, making your trades more efficient. The algorithm does all the work for you; that way, you can ensure better efficiency and zero emotional interference with your trades.
2. Pro: Efficient in Liquid and Illiquid Markets
HFT is a workable method of trading in liquid and illiquid markets. This is because the whole trade usually happens almost immediately, and there is no demand for high-market liquidity. Moreso, it also allows the users to exploit price changes before they fully appear in the order book.
3. Pro: Provides Market Liquidity
High-frequency trading can improve market conditions since it usually involves many trades. It also provides a constant flow of liquidity in the market, which helps to maintain tight ask and bid prices.
4. Con: Possibility of Huge Losses
The strategy places a lot of trust in algorithms. Unfortunately, the algorithms are only as good as their creators. Therefore, you could lose a lot of money or your entire trading balance if there is any error in its makeup.
5. Con: Ghost Liquidity
The liquidity the trading style provides is controversial since it disappears quickly. The trading time for HFT is very short, and as a result, many traders may be unable to take advantage of it. For this, it can be concluded that the liquidity provided by HFT isn't so useful for the market.
Can Retail Traders Get Involved in High-Frequency Trading?
High-frequency trading requires a trading frequency close to or even at the big market players' stage, making it difficult for everyday traders to trade. The algorithmic requirements are high. Executing the trades requires you have powerful computers to analyze and execute large trades in seconds.
Only a few traders have the resources to buy high-tech systems that make the trading style work. This is not to say that retail traders cannot get involved in any form of algorithmic trade—there are many automated trading strategies that day traders can get for a price. Some automated trading bots are also created to operate closely to how a proper HFT trading strategy works. However, the difference is always clear.
High-Frequency Trading Isn't Beginner-Friendly
HFT trading style is not beginner-friendly and isn't a game for amateurs. We suggest those new to trading start by carrying out manual trades before trying any algorithmic or automated trading. However, if you don't have the time to learn how to trade or to trade yourself, opting for automated strategies could be a good option. You could also try out crypto social trading, which gives professionals the chance to manage your money while you still have a reasonable level of control over it.