Policy Documents

The Diversity of High Frequency Traders

Björn Hagströmer and Lars L. Norden –
September 27, 2012

The regulatory debate concerning high frequency trading (HFT) emphasizes the importance of distinguishing different HFT strategies and their influence on market quality. Using unique data from NASDAQ OMX Stockholm, we are the first to empirically provide such a distinction for equity markets. Comparing the behavior of market making HFTs to opportunistic HFTs (arbitrage and momentum HFT strategies), we find that market makers constitute the lion share of HFT trading volume (63-72%) and limit order traffic (81-86%). Furthermore, market makers have higher order-to-trade ratios, lower latency, lower inventory, and supply liquidity more often than opportunistic HFTs. In a natural experiment based on tick size changes, we find that both market making and opportunistic HFT strategies mitigate intraday price volatility. The findings indicate that, e.g., the financial transaction tax proposed by the European Commission, which would render most HFT strategies unprofitable, would primarily hit market makers and increase market volatility.