High-Frequency Trading Strategies

Abstract

We examine the effect of high frequency trading on market quality from the perspective of a limit order trader. By competing with slower limit order traders, high frequency traders (HFT) impose a welfare externality by selectively crowding out the most profitable limit orders. The order book imbalance immediately before each order submission, cancelation and trade suggests that high frequency traders strategically use limit order book information to supply liquidity on the thick side of the order book and demand liquidity from the thin side. This strategic behavior is more pronounced during volatile periods and when trading speeds increase.

Keywords: High-frequency trading, institutional investors, retail investors

JEL Classification: G14; G15