The High Frequency Trading Tactic That Reduces Market Liquidity

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The two arguments you typically hear in defense of high frequency trading are that it improves price discovery and supplies market liquidity, which has at least some backing in academic research. But HFT firms use lots of different tactics at their disposal, and looking at the firm-wide impact may be too broad to identify trading strategies that reduce market quality. Instead of categorizing trades by who is doing them, a paper by Álvaro Cartea, Richard Payne, José Penalva, and Mikel Tapia finds that rapidly placing and cancelling limit orders significantly reduces liquidity and increases buy/sell spreads. A one standard deviation…

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