Policy Documents

High Frequency Trading and the New-Market Makers

Albert J. Menkveld –
February 6, 2012

This paper links the recent fragmentation in equity trading to the arrival of high-frequency traders (HFTs). It documents how three events coincided: a new market’s take-off, the arrival of a large HFT, and a 50% drop in the bid-ask spread. Detailed analysis of the HFT’s trading strategy reveals that 80% of its trades were passive, i.e., its price quote was consumed by others. It participated in 14.4% of all trades, it was extremely fast, and, per trade, it earned a net EUR1.55 on the spread but lost EUR0.68 on its position. In sum, the HFT that ‘made’ the new market looks much like an electronic version of the classic market maker.