Working Paper No. 469
By Evangelos Benos and Satchit Sagade
We analyse the intraday behaviour of high-frequency traders (HFTs) and its impact on aspects of market quality such as liquidity, price discovery and excess volatility. For that, we use a unique transactions data set for four UK stocks, over the period of a randomly selected week. Our data identifies the counterparties to each transaction, enabling us to track the trading behaviour of individual HFTs. We first find that HFTs differ significantly from each other in terms of liquidity provision: while some HFTs mostly consume liquidity (ie trade more ‘aggressively’) by primarily executing trades via market orders, others mostly supply liquidity (ie trade more ‘passively’) by primarily executing trades via limit orders. To examine how trading behaviour is related to these patterns of liquidity provision, we split the HFTs in two groups, according to their trade aggressiveness, and examine the behaviour and impact of each group separately. We find that the ‘passive’ HFTs follow a trading strategy consistent with market making and as such their trades have alternating signs and are independent of recent (ten-second) price changes. By contrast, ‘aggressive’ HFTs exhibit persistence in the direction of their trades and trade in line with the recent (ten-second) price trend. We then explore the relationship between HFT activity and market quality. We find that both higher price volatility and lower spreads cause HFT activity to increase. We suggest a number of reasons as to why this might be so. Finally, we use a tick time specification to examine the impact of HFT activity on price discovery (ie information-based volatility) and noise (ie excess volatility). We find that while HFTs have a higher information-to-noise contribution ratio than non-HFTs, there are instances where this is accompanied by a large absolute noise contribution.
High-frequency trading behaviour and its impact on market quality: evidence from the UK equity market