How Aggressive Are High‐Frequency Traders?

• Author: Björn Hagströmer,Lars Nordén,Dong Zhang
• Published date: 01 May 2014
• DOI: http://doi.org/10.1111/fire.12041
• Date: 01 May 2014

The Financial Review 49 (2014) 395–419

How Aggressive Are High-Frequency

Traders?

Bj¨

orn Hagstr¨

omer

Stockholm University School of Business

Lars Nord´

en∗

Stockholm University School of Business

Dong Zhang

Stockholm University School of Business

Abstract

We study order aggressiveness of market-making high-frequency traders (MM-HFTs),

opportunistic HFTs (Opp-HFTs), and non-HFTs. We find that MM-HFTs follow their own

group’s previous order submissions more than they follow other traders’ orders. Opp-HFTs

and non-HFTs tend to split market orders into small portions submitted in sequence. HFTs

submit more (less) aggressive orders when the same-side (opposite-side) depth is large, and

supply liquidity when the bid–ask spread is wide. Thus, HFTs adhere strongly to the tradeoff

between waiting cost and the cost of immediate execution. Non-HFTs care less about this

tradeoff, but react somewhat stronger than HFTs to volatility.

Keywords: high-frequency trading, aggressiveness, order submission, liquidity, volatility

JEL Classifications: G14, G18

∗Corresponding author: Stockholm University,School of Business, S-106 91 Stockholm, Sweden; Phone:

+46 8 6747139; Fax: +46 8 6747440; E-mail: ln@fek.su.se.

We would like to thank NASDAQ OMX Group Inc. for providing the data, and Petter Dahlstr¨

om and

Frank Hatheway for numerous discussions about the data and market structure. Helpful comments from an

anonymous referee, Jonathan Brogaard, Michael Goldstein (the guest editor), and seminar participants at

Lund University (Arne Ryde Workshopin Financial Economics), Gothenburg University, and University

of London (Seventh International Conference on Computational and Financial Econometrics), are also

gratefully acknowledged. All three authors are grateful to the Jan Wallanderand Tom Hedelius foundation

and the Tore Browaldhfoundation for research support.

C2014 The Eastern Finance Association 395

396 B. Hagstr¨

omer et al./The Financial Review 49 (2014) 395–419

1. Introduction

In modern equity markets, traders differ in technology,sophistication, and strat-

egy. Retail and institutional investors coexist with proprietary traders who use com-

puters to pursue strategies with subsecond investment horizons. These traders may

base their decisions on the limit order book, which conveys the current state of liq-

uidity supply and demand to its participants. Limit orders may be characterized by

their aggressiveness, which the trader chooses by setting the limit price that leads

to immediate or to some extent delayed expected execution. Collectively, the ag-

gressiveness of all limit orders forms the supply and demand of liquidity. Order

aggressiveness is thus fundamental to the market quality variables that are central to

market microstructure research.

In this paper, we examine the interaction between limit order aggressivenessand

trader type. Specifically, we categorize limit orders and the limit order book by the

level of aggressiveness and investigate empirically how order aggressiveness differs

between traditional traders and different types of high-frequency traders (HFTs). By

conditioning order aggressiveness on the state of the order book as well as the actions

of other traders, we provide new insights into the functioning of electronic limit order

book markets.

The theoretical literature shows that order aggressiveness is determined by the

tradeoff between waiting costs and the cost of immediate execution.In Parlour (1998),

traders choose to submit limit orders or market orders based on their observation of

the limit order book depth. Foucault (1999) suggests that market orders are more

costly when the asset volatility is higher. Foucault, Kadan and Kandel (2005) model

how traders’ impatience determines their order placement strategies, and Ros¸u (2008)

holds competition in liquidity supply as a key variable for order aggressiveness. The

cost of immediacy is the same for all traders, but waiting costs may differ with the

sophistication of the trader. For example, an HFT may have the means to evaluate

patterns in order submissions of other traders before deciding what orders to submit,

whereas a slow trader does not have the capacity for such an analysis. Empirical

evidence of such differences are provided by Hendershott and Riordan (2013), who

show that algorithmic traders have an edge in revising their orders quickly following

public news announcements.

Several empirical articles analyze how order submission strategies depend on

the state of the order book (Griffiths, Smith, Turnbull and White, 2000; Handa,

Schwartz and Tiwari, 2003; Ranaldo, 2004) and the actions of other traders (Biais,

Hillion and Spatt, 1995). Due to data restrictions, most empirical analyses focus on

trading and quoting strategies at an aggregate level.However, as order submissions are

increasingly automatic, it is important to understand the differences between human

and different types of automatic order submissions. Hendershott and Riordan (2013)

study the interaction of order submissions between human traders and algorithmic

traders at the Deutsche B¨

orse. Brogaard (2010) analyzes the segment of algorithmic

traders that perform proprietary trading only, referred to as HFTs, and focuses on the