High Frequency Trading, Market Volatility and Trading Counterparty Performance

Abstract

The findings in this paper confirm that there is an economic and statistic negative association between High Frequency Trading [HFT] activity and price volatility. In the ultra-high frequency intervals around HFT there is a slight increase in volatility. This paper also confirms that large high frequency traders make consistently profitable trades intra-day, but their performance is also highly impacted by the overnight positions they hold. The counterparties of high frequency traders are found to endure significant and consistent short term costs. Most HFT occur within the category of high frequency traders, other common counterparties are buy side institutional investors and financial firms, typically not households. The bulk of the large short term returns earned by the largest HFT firms are generated from trading with other smaller HFTs and slower intermediaries. I suggest that the relatively moderate costs suffered by institutional counterparties to HFT, may be justified as a compensation for liquidity and fast execution.