High frequency trading

High speed computer trades

High frequency trading uses computers, rather than people, to generate buy and sell orders on markets such as Chi-X and the Australian Securities Exchange (ASX). There are concerns that this type of trading may lead to disorderly markets and market manipulation.

Here we explain high frequency trading, the benefits and some of the risks involved. 

What is high frequency trading?

High frequency trading (also known as HFT and 'robot trading') is a type of trading that uses very fast computer programs to enter orders and execute trades on a market. These trades can be executed a lot quicker than trades made by humans.

Because the buy and sell orders can be generated so quickly, multiple trades can also occur at great speed. Profits or losses are made on the difference in the buy and sell price.

The benefits

High frequency trading can add liquidity to markets which may in turn assist market pricing by ensuring the gap between 'the bid' (the highest price a buyer is willing to pay) and 'the ask' (the purchase offer) is not too wide.

It can also help ensure consistent pricing across different markets which trade the same products or stocks. 

The risks

Market disorder can happen when, with no human intervention, an 'aberrant algorithm' in the computer program enters orders and trades (sometimes in vast numbers) by mistake.

If the algorithm malfunctions and quickly places many orders and trades (sometimes with itself), this can have a severe impact on the market and can lead to 'disorderly trading'.

Some investors, including those that trade in large volumes, are concerned that high frequency trading may be interfering with trades made by both institutional and retail investors.

Regulating high frequency trading

High frequency trading is legal as long as it complies with relevant ASIC market integrity rules and the Corporations Act.

ASIC is planning to create new rules on automated trading, including the requirement for systems to have a 'kill-switch', which will immediately turn off a faulty algorithm and reduce volatility. Additional controls will also be compulsory to prevent trades from occurring where unusual extreme volatility occurs. For more information, see ASIC's media release about new market integrity rules. 

Like any trading, high frequency trading has benefits as well as risks. This type of trading is part of our markets and you need to be aware of this when you are trading shares.

Related links

Last updated: 18 Aug 2015