Algorithmic (Algo) Trading is sometimes used as an interchangeable word with high-frequency trading (HFT) but there are some differences between both of them. These two types of trading techniques are nowadays popular and also used by traders across various segments of the financial markets.
To make the right use of both of them in trading or investing you need to understand the difference between algorithmic trading and high frequency trading. Algo trading is a broader term and high-frequency trading is a sub-set of Algo trading but both are different in terms of operational frequencies.
What is Algorithmic Trading?
Algo trading is a type of software or web-based application that works on a certain predefined set of rules and conditions to work as per the user’s applicability and execution. It is a kind of automated trading solution and can work automatically without human intervention.
Algo is capable enough to place trade orders, book profit or exit from the trade positions. It can be used on the predefined sets of various rules like price, volume and time based on various market conditions. By using Algo you can trade with various prebuilt strategies or you can customise your own trading strategy.
Recommended Read: Use Algo Trading for Faster Trades
What is High-Frequency Trading?
High-frequency trading or HFT is a subset of Algo Trading but it is different from Algo in terms of high speed trades, huge turnover and high ratios of orders. HFT is used to operate with highly complex algorithms and other sophisticated technologies to trade in various market conditions.
To run the HFT software you need a highly efficient powerful computer system with the capability to run without lagging to execute the various transactions with high accuracy. It is generally used to manage and send small-scale orders to the exchange at very high speed.
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Difference between HFT and Algo Trading:
| Aspects | Algorithmic Trading | High-Frequency Trading |
| Definition | Algo trading is simply a software or application developed to work automatically to perform various actions like selecting the trading strategy as per the market conditions and execution of trades etc. | HFT is characterized by high-speed transactions with the capability to generate high turnover to generate a high volume of trades in the market using highly complex tools and algorithms. |
| Mechanism | The Algo software or app works on a set of predefined rules and conditions developed through programming. It is not highly complicated but still requires some level of complexities to execute orders. | HFT is developed with and works with a highly complicated and sophisticated technological setup. The level of complexities makes it capable enough to perform the transactions at very high speed and efficiency. |
| Order Management | The order management is based on the type of trading strategies selected in the Algo that works as per the predefined conditions meant to execute the transactions. | HFT works to manage large orders by sending small-scale orders to the exchange at a very high speed to generate a high volume of trades in minimum time. |
| Efficiency
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Algo is highly efficient in automating various trading tasks, enabling timely order placements and exits from positions according to the trading strategies. | HFT is highly efficient in trading multiple high-speed transactions to generate high volumes of trades. It can run at the speed of up to milliseconds or even microseconds. |
| Impact on Market | Algo trading works smoothly and has a less pronounced impact on the movement of the market. In fact, it works as per the changing market conditions. | Due to the execution of high speed and large volumes of trades in milliseconds, HFT can have a significant impact on the market liquidity and volatility. |
| Trading Strategies | In Algo trading, you can find various types of popular trading strategies based on fundamental or technical analysis that can be implemented on the basis of the latest market conditions. | HFT mainly works with the strategy to take advantage of even smaller price differences of the various underlying securities trading in the different exchanges or markets. |
| Popular Strategies | By trading with Algo you can find various popular trading strategies like trend-following, arbitrage leveraging, index fund rebalancing, mean reversion and mathematical model-based. | In HFT, the popular trading strategies are market-making, liquidity provision, statistical arbitrage and price movement ignition that can be used in various market conditions. |
| Risk Management | In Algo trading, you can use popular risk management practices like trade with stop-loss or use position sizing techniques to minimize the chances of losses in unexpected market conditions. | HFT, technical glitches or system failures are the major risk factors that are managed with the right infrastructure development to organize such transactions without any technical issues. |
| Regulatory Actions | Usually, Algo trading software is not scrutinised too much and receives less intensive monitoring from regulatory authorities. | HFT is subject to regulatory scrutiny with a close monitoring system as it can work unfairly or destabilize the market movement. |
| End Users | Algo trading is popular among all the categories of traders including retail and institutional investors due to its availability, affordability and compatibility to use. | Institutional traders or investors mainly use HFT due to the high cost of infrastructure and resources required to implement, operate and manage this smoothly. |
Wrapping-up
Algo trading works on a predefined set of instructions developed through certain algorithms for automated trading. It can be used by all types of traders to enable an automatic trading system by choosing the strategy as per the market conditions. To trade with Algo you need an application or trading software in which you can customize your trading strategy or choose the existing one as per the market conditions.
HFT is a set of programming or you can say a trading mechanism to perform large volumes or transactions at very high speed. It is mainly used by institutional traders to trade with multiple transactions at lightning speed to generate the high volume of trades. However, HFT is a more complicated and sophisticated trading system compared to Algo trading software or applications.
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