This paper examines the impact of high frequency trading (HFT) on the U.S. equities market. I analyze a unique dataset to study the strategies utilized by high frequency traders (HFTs), their profitability, and their relationship with characteristics of the overall market, including liquidity, price discovery, and volatility.
The 26 high frequency trading firms in the dataset participate in 73.7\% of all trades. I find the following key results:
(1) HFTs tend to follow a price reversal strategy driven by order imbalances
(2) HFTs earn gross trading profits of approximately \$2.8 billion annually
(3) HFTs do not seem to systematically engage in a non-HFTr anticipatory trading strategy
(4) HFTs’ strategies are more correlated with each other than are non-HFTs’
(5) HFTs’ trading level changes only moderately as volatility increases
(6) HFTs add substantially to the price discovery process
(7) HFTs provide the best bid and offer quotes for a significant portion of the trading day and do so strategically so as to avoid informed traders, but provide only one-fourth of the book depth as do non-HFTs
(8) HFTs may dampen intraday volatility
These findings suggest that HFTs’ activities are not detrimental to non-HFTs and that HFT tends to improve market quality.
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