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 crowding out slower non-HFT
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