Do High-Frequency Traders Anticipate Buying and Selling Pressure?

Abstract:     

High-frequency traders (HFTs) accounted for 40% of NASDAQ volume in 2009, but we know little about how their trading affects liquidity. This study examines one means by which HFTs could increase non-HFTs’ trading costs — namely, by anticipating and trading ahead of their order flow. I find that HFTs’ aggressive purchases and sales lead those of other investors. The effect is stronger at times when non-HFTs may be more impatient, such as near the market open, on high volume and high imbalance days, and for stocks with wide bid-ask spreads. I explore whether these results are explained by HFTs reacting faster to news, positive-feedback trading by non-HFTs, or HFTs and non-HFTs trading on the same signals, but the results are best explained by the anticipatory trading hypothesis. Consistent with the idea that such trading is related to HFT skill, there is persistence in which HFTs’ trades best forecast order flow, and these HFTs’ trades are more highly correlated with future returns. While it is probable HFTs on net improve liquidity, these findings support the existence of an anticipatory trading channel through which HFTs may increase non-HFT trading costs.

Number of Pages in PDF File: 73

JEL Classification: G10, G14