Are high frequency traders responsible for extreme price movements?

Abstract

This is the first paper to investigate the association between losses to liquidity providers and price jumps, separately for high frequency traders [HFT] and low frequency traders. Highly reliable data from Nasdaq identifies the trade direction of each trade and the trades that have HFT participation. To determine if trades executed by high or low frequency traders are more frequently associated with a price jump, we use the volume-synchronised probability of informed trading [VPIN] metric. We find that VPIN rapidly increases prior to a price jump but does not peak until after a price jump. HFT liquidity demand and supply prior to a price jump shows that HFT reduce their trading prior to price jumps. Low frequency traders hence remain as the main market participants during price jumps and are the information channel that leads to price jumps. Regulators and broker–dealers can implement strategies to protect investors against price jumps when VPIN rapidly increases and the proportion of HFT to other traders falls.