High-Frequency Trading and Price Discovery
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What they found
Using a Nasdaq dataset that flags trades by 26 high-frequency trading firms in 2008 and 2009, the authors examined whether HFTs help or hurt price discovery. HFTs traded in the direction of permanent price changes and against transitory pricing errors, both on the aggregate and in individual stocks, and their liquidity-demanding trades were the most informative. In other words, HFTs pushed prices toward efficient values and profited from doing so, including on days of high volatility.
What you can use
- HFTs are on the right side of the next price move more often than not; being on the other side of them is expensive.
- Short-term pricing errors get corrected in milliseconds by HFTs, so retail short-term 'mispricing' trades are competing with them directly.
- HFT activity is highest in large, liquid stocks; that is where speed matters most and where retail has the least edge on timing.
Caveats
Sample covers 120 stocks over two years around the 2008 crisis, and identifies only firms Nasdaq classified as HFTs. Correlation between HFT trades and price moves does not prove HFTs cause efficient pricing.
Tags: microstructure, hft, price-discovery
Summaries are our own reading of the paper, not the authors' words. Educational only, not advice. Discuss it in Book Club.