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Key Takeaways
- HFT uses low-latency systems to generate, update and execute orders at high speed.
- Market making, arbitrage and short-term directional trading use different order and inventory strategies.
- Automated option quotes respond to the underlying, volatility and inventory across strikes and expirations.
- The worked 20-contract buy fills at two prices and averages $2.50.
- Control the fill with a limit price and time-in-force, and judge it from the execution report: the 20-contract market buy paid $100 more than the $2.45 offer.
What is high-frequency trading (HFT)?
High-frequency trading, or HFT, is proprietary trading that uses low-latency technology to submit, update and execute orders at high speed. Firms use it for market making, arbitrage and short-term directional trading. Colocation, direct data feeds and fast connections shorten the path from a market event to an order decision.
Automated market makers post and revise bids and offers as prices, volatility and inventory change. Options quoting applies that process across strikes and expirations linked to the same underlying.
Formula
Order-to-trade ratio = total order messages / executed trades- Count new orders, modifications and cancellations in the defined order-message total.
- Divide by executed trades over the same observation period.
- For example, 12,000 order messages and 1,000 trades produce a ratio of 12 to 1.
Order execution example: filling 20 contracts across two prices
A trader sends a market buy for 20 XYZ call contracts. At matching, ten contracts are available at $2.45 and the next eligible offer is $2.55 with enough contracts to complete the order. Each contract has a 100-share multiplier. Explicit fees are zero.
- First fill: 10 contracts × $2.45 × 100 = $2,450
- Second fill: 10 contracts × $2.55 × 100 = $2,550
- Average price paid: ($2,450 + $2,550) / (20 × 100) = $2.50 per share
- Cost versus the displayed offer: ($2.50 − $2.45) × 20 × 100 = $100
The two fills cost $5,000 and average $2.50, which is $100 above buying all 20 contracts at the initial $2.45 offer. Against this same available book, a resting $2.45 buy limit executes ten contracts and leaves ten open.
Buying all 20 at the initial $2.45 offer would cost $4,900, so sweeping past the displayed size costs $100. That top-of-book size is what automated market makers committed at $2.45, and the rest of the order pays the next price up.
Against that same available book, a resting $2.45 buy limit fills ten contracts and leaves ten open. An immediate-or-cancel instruction cancels its unfilled balance, so pick the price limit and the time-in-force as one decision.
Order-to-trade ratio, quotes and trades
An order-to-trade ratio divides the defined order-message count by executed trades over the same period. A sample with 12,000 messages and 1,000 trades has a ratio of 12 to 1.
Quotes describe offered trading interest. Prints describe completed transactions. Use the execution report to calculate filled quantity and cash cost, and use market data to compare the surrounding quote and activity.
Options flow shows contract activity by strike and expiration, and the options profit calculator compares a structure’s payoff at alternative entry prices and, after execution, at the actual fill prices.
Limitations of high-frequency trading data
- Check the definition behind any HFT statistic. Reports and studies use different criteria, so compare figures only when they count HFT the same way.
- Trade the liquidity, whoever posts it. Public quotes and prints carry no firm identity, so judge each price by its displayed size and how fast it refreshes.
- Read the order-to-trade ratio with its message count. A high ratio reflects frequent quote updates, while a spoofing case turns on orders placed with the intent to cancel them.
- Expect different effects from different strategies. Market making posts liquidity, arbitrage links prices across venues and directional strategies trade short-term moves, so HFT has no single effect on spreads or fills.
- Cap a sweep with a limit price. A market order fills against the book as it stands at matching, not as it looked when the order was sent: in the worked buy, only ten contracts are available at $2.45, so the rest fills at $2.55.
Bottom line
High-frequency trading uses low-latency systems to quote and trade as markets change, so the displayed book can update between your decision and your fill. Control your own execution with the complete quantity, a limit price and a time-in-force, and judge the result from the execution report rather than the quote you saw.
Clear answers
Frequently Asked Questions
Sources and Further Reading
- SEC Staff: Equity Market Structure Literature Review Part II, High Frequency Trading
- SEC Staff Report on Algorithmic Trading in U.S. Capital Markets
- FINRA Regulatory Notice 15-09: Guidance on Effective Supervision and Control Practices for Algorithmic Trading Strategies
- Cboe: Options Exchange Liquidity Providers
How entries are sourced, calculated and updated: editorial methodology.