Police said they swooped on an industrial building in the district of Tsuen Wan on Friday evening and arrested a 27-year-old man.
"We are dealing with a homemade laboratory for the manufacture of high explosive, specifically TATP," Superintendent Alick McWhirter, a bomb squad specialist, told reporters on Saturday.
"This is an extremely sensitive and extremely powerful high explosive. It will cause exceptional amounts of damage when used," he added.
TATP requires skill to manufacture but has been used in a number of major terror attacks, including the 2005 London suicide bombings and the recent deadly Easter attacks on hotels and churches in Sri Lanka earlier this year.
McWhirter said his team had carried out at least one controlled explosion and expected to do more because the TATP they had discovered was volatile.
Items also displayed by police after the raid included a T-shirt with the logo of the Hong Kong National Front, a pro-independence group, as well as leaflets related to huge anti-government protests currently engulfing the international finance hub.
The Hong Kong National Front, a small fringe group, released a statement on Facebook saying the man arrested was a member but added it had no knowledge of any explosives.
In November 2017, two members of a fringe independent group were found guilty of making explosives and were jailed.
Under the 1997 handover deal with the British, China promised to allow Hong Kong to keep key liberties such as its independent judiciary and freedom of speech.
But many say that 50-year deal is already being curtailed, citing the disappearance into mainland custody of dissident booksellers, the disqualification of prominent politicians and the jailing of democracy protest leaders.
Authorities have also resisted calls for the city's leader to be directly elected by the people.
A small number of pro-independence groups have since emerged but they remain fringe elements with little popular support.
'We are dealing with a homemade laboratory for the manufacture of high explosive, specifically TATP,' Superintendent Alick McWhirter, a bomb squad specialist, told reporters on Saturday