The German Bundesbank recently published a report on high-frequency trading and its impact en German capital markets. Following the increase of algorithmic trading over the last 10 years on international stock markets and considering the limited availability of reliable data, the German National Bank has conducted intensive research to gain a better understanding of the role of HFTs.
The study comes to the conclusion that it is difficult to come up with generic conclusions. Developments on financial markets depend heavily the respective strategies and particular trading situations. The report states that during quiet market situations high-frequency traders contribute significantly to the overall liquidity. However the report also points out that this contribution to market liquidity is not continuous, but rather temporarily in particular in times of volatility.
The report is based on the review of two different sets of data. The first set looks at trading in DAX- and Bund-Future during the second week of March 2014 – during the Ukraine/ Crimea crisis – while the second reviews a rather quiet week between 3rd and 10th June 2014, when the German index reached a new all-time high. The study gives an overview on high-frequency trading, its actors as well as HFT strategies and the behaviour in different market situations. The report also discusses the question whether some high-frequency traders use superior technology to gain an unfair advantage on other market participants. The writers criticise that this discussion is often based on week empiric data and biased observations, in particular with regard to use of limit orders and successive rapid deletion. While the study itself considers that with respect to its collected data the vast majority of deleted limited orders does not give any reason for concern, it also states that a small percentage of trades in question could have an abusive character.
In his conclusive statement and outlook the writers summarise that high-frequency traders participate more in times of volatility, both during periods off unexpected volatility as well as in anticipation all increased market movements. Especially, following the publication of significant news HFTs are able to take advantage thanks to faster technology, which leads on one hand to better pricing within a short time periods and on the other hand increases volatility. At the same time the Results indicate that passive high-frequency traders call out during volatile market situations and thereby reduce liquidity. Combined the behaviour of active and passive HFTs seems to lead to risk of short periods of increased volatility, which in turn could result in flash events. While the reconstruction of the order book for DAX-Futures underlines the important role of passive HFTs for the general liquidity, the results in respect of Bund-Futures showed that liquidity reduces during times when significant market news are published.
The report ends with the notion that the imperial results of the study are also relevant for the regulatory discussion on HFT. First, did demonstrate how important the implementation of incentives is to ensure that passive high-frequency market-makers maintain the provision of liquidity during times of market stress, too. Second, the results indicate that active high-frequency traders because of this superior technology contribute to excessive temporary volatility.
The full report (in German) can be found here.