High frequency traders (HFTs) use computers to implement various highly active trading strategies to trade at exchanges where automated electronic systems arrange trades. Electronic dealers are the most common HFTs. They post standing limit orders to buy or sell securities or contracts and wait for others to trade with them.
After they trade, HFTs generally try to immediately trade on the other side of the market to divest themselves of their positions. They hope to profit by buying low and quickly selling high. Sometimes they can trade out of their positions by posting standing limit orders and waiting for other traders to trade with them. When this happens, they often profit.
But if they believe that the market will move against them, they may be unwilling to wait to trade. Instead, they will actively trade out of their positions by submitting market orders or marketable limit orders. In these cases, they often lose.
HFTs frequently adjust their orders to respond to changing market conditions. These adjustments may occur several times a second.
HFTs use extremely fast computer systems to implement their trading strategies. The time between when an event (generally a trade or quote change) takes place on an exchange and when a HFT is able to respond to that event is often less than one millisecond. During this period, electronic systems will disseminate information about the event. The HFT’s computer will analyse the information, choose a response and submit instructions to the exchange. The electronic systems will route those instructions to the exchange.
HFTs must respond to new information quickly to trade profitably. Speed helps them in three ways:
First, they try to be the first to place an order at an attractive price because the first trader in is the first trader out.
Second, they must quickly cancel their orders to prevent trades that they are no longer willing to do.
Finally, when they want to actively trade with a standing order, they must arrange the trade before other traders can and before the order is cancelled.
To trade quickly, HFTs use very fast computers with highly optimised code. They also co-locate those systems next to exchange computers to minimise communication time lost to sending messages at the speed of light and lost to passing messages through routing switches.