What HFT actually does
HFT encompasses several distinct activities. Electronic market-making is the most common: HFT firms continuously post bids and offers on both sides of the market, earning the bid-ask spread thousands of times per day while managing inventory risk with extreme precision. Latency arbitrage exploits tiny price discrepancies that exist across different exchanges for fractions of a second — buying on one exchange and selling on another before prices equilibrate. Statistical arbitrage applies mean-reversion and momentum models at ultra-short time horizons. These activities look similar in description but differ enormously in their market impact.
The infrastructure arms race
Speed in HFT is determined by physics: light takes approximately 33 microseconds to travel 10 kilometres. HFT firms co-locate their servers inside exchange data centres to minimise transmission time. They have laid private microwave networks (faster than fibre for long distances) between major exchanges. Firms have spent hundreds of millions on dedicated cables — including a transatlantic cable optimised to reduce latency between the NYSE and the London Stock Exchange by a few milliseconds. This infrastructure investment creates a significant competitive moat that only a handful of firms can sustain.
The benefit: tighter spreads
The strongest argument for HFT is empirical: bid-ask spreads have compressed dramatically since electronic market-making replaced human specialists. A stock that cost 25 basis points to trade in 2000 might cost 1–2 basis points to trade today. For long-term institutional investors who trade frequently, this saving is substantial and real. Studies generally confirm that HFT electronic market-makers provide genuine liquidity at competitive prices in normal market conditions.
The critique: phantom liquidity and flash crashes
The May 6, 2010 "Flash Crash" saw the Dow Jones fall 1,000 points and recover within minutes, triggered partly by HFT liquidity withdrawal — firms cancelled quotes and stopped making markets simultaneously during stress, causing prices to overshoot dramatically. Critics argue that HFT "liquidity" is ephemeral: available during calm periods but withdrawn precisely when it is most needed. "Front-running" — where HFT firms detect incoming institutional orders and trade ahead of them — is another concern, though its prevalence and legality are contested.
"HFT doesn't add value to the real economy — but neither does most trading. The question is whether it makes market prices more or less informative at lower or higher cost to real investors." — A market microstructure debate summary
What this means for you
For retail investors using limit orders and trading liquid ETFs and large-cap stocks, HFT likely benefits you through tighter spreads. The HFT tax — if it exists — falls primarily on institutional investors executing large block orders who must navigate adverse selection. Understanding HFT dynamics explains why execution quality matters: using limit orders, breaking up large orders, and trading during high-liquidity periods (rather than at the open or close) reduces your exposure to adverse HFT interaction.