High Frequency Trading (HFT) refers to the use of sophisticated computer algorithms to execute a large number of orders on financial markets at an extremely high speed, often in milliseconds or even microseconds. This practice, which emerged in the early 2000s with the digitalization of markets, has profoundly transformed the microstructure of stock markets. According to the Bank of France, HFT accounted for approximately 40% of the traded volumes on European equity markets in 2023 (Bank of France, 2023).
Creation and Extraction of Liquidity by HFT
HFT plays an ambivalent role in market liquidity. On one hand, HFT algorithms provide liquidity by continuously displaying bid/ask quotes, which reduces transaction costs and improves order book depth. On the other hand, some algorithms seek to extract this liquidity through so-called "market making" or "latency arbitrage" strategies.
Liquidity is measured notably by the size of orders available at each price level and the speed at which orders can be executed without significant price impact. A 2022 study by the Autorité des Marchés Financiers (AMF) indicates that HFT algorithms provide on average 30% to 50% of the displayed liquidity on the CAC 40 (AMF, 2022).
However, this displayed liquidity is sometimes described as "fragile" because algorithms can quickly withdraw their orders in times of high volatility, which can cause erratic price movements.
The 2010 Flash Crash: A Striking Example
On May 6, 2010, the Dow Jones Industrial Average plunged nearly 1,000 points within minutes, about 9%, before almost fully rebounding. This event, called the Flash Crash, highlighted the risks associated with HFT. A detailed analysis by the SEC (Securities and Exchange Commission) showed that the initial trigger was a massive automated sale by an index fund, which was amplified by HFT algorithms withdrawing their liquidity in response to increasing volatility (SEC, 2010).
This phenomenon demonstrated that the speed and complexity of algorithms can amplify market imbalances and create temporary instabilities. Since then, regulators have strengthened control mechanisms, notably by introducing "circuit breakers" to temporarily halt trading in case of excessive movements.
Impact of HFT on Spreads and Transaction Costs
Spreads, i.e., the difference between the bid and ask prices, are a key indicator of liquidity and transaction costs in markets. HFT generally contributes to reducing these spreads by continuously offering competitive prices.
Year
Average Spread on CAC 40 (%)
HFT Volume (%)
2010
0.15
25
2015
0.10
35
2023
0.07
40
Source: AMF (2023)
A clear correlation is observed between the increase in HFT’s share and the decrease in spreads, which benefits investors by reducing transaction costs.
What Individual Investors Should Know About HFT
For the individual French investor, HFT may seem opaque or even worrying. However, understanding its mechanisms is essential:
Advantages: thanks to HFT, orders are executed faster and at lower costs, especially on large liquid stocks such as those in the CAC 40.
Risks: during periods of high volatility, liquidity provided by algorithms can be abruptly withdrawn, increasing volatility and making orders more expensive to execute.
Impact on strategy: long-term strategies are not directly affected by HFT. However, active investors or day traders must be aware that prices can change within milliseconds, requiring the use of robust and fast platforms.
Finally, European regulation (MiFID II) has imposed strict rules since 2018 governing HFT, notably regarding transparency and risk management, which indirectly protect individual investors.
Conclusion
High Frequency Trading is an essential player in modern financial markets. It significantly contributes to liquidity and the reduction of transaction costs, as evidenced by the decline in spreads on major European indices. However, its ability to rapidly extract liquidity during stress periods can increase volatility and the risk of temporary imbalances, as seen during the 2010 Flash Crash.
For the individual French investor, HFT should not be a source of anxiety but rather a reality to understand: it facilitates market access through reduced costs but also requires increased vigilance during periods of high volatility. European regulation has strengthened the safety around these practices, providing a safer framework.
Verdict: HFT overall improves market quality, but individual investors should favor a long-term approach and avoid being caught by the increased volatility induced by these algorithms during crises. Using brokers that offer fast and reliable execution is imperative to limit risks related to HFT.
