High-Frequency Trading: A Practical Guide to Algorithmic Strategies and Trading Systems

Chapter 4. Financial Markets Suitable for High-Frequency Trading

A wide range of securities and numerous market conditions fit the profile for trading at high frequencies. Some securities markets, however, are more appropriate than others. This chapter examines the topic of market suitability for high-frequency trading.

To be appropriate for this type of trading, two requirements must be met: the ability to quickly move in and out of positions and sufficient market volatility to ensure that changes in prices exceed transaction costs. The volatilities of different markets have been shown to be highly interrelated and dependent on the volume of macroeconomic news reaching the markets. The ability to quickly enter into positions as well as to close them is in turn determined by two factors: market liquidity and availability of electronic execution.

Liquid assets are characterized by readily available supply and demand. Liquid securities such as major foreign exchange pairs are traded 24 hours a day, 5 days a week. Less liquid securities, such as penny stocks, may trade only once every few days. Between trades, the prices on illiquid assets may change substantially, making less liquid securities more risky as compared with more liquid assets.

High-frequency strategies focus on the most liquid securities; a security requiring a holding period of 10 minutes may not be able to find a timely counterparty in illiquid markets. While longer-horizon investors can work with either liquid or illiquid ...