On 2 June 2016, the Netherlands Authority for the Financial Markets (Autoriteit Financiële Markten, the AFM) published the results of its in-depth investigation into the trading strategies of high-frequency traders (HFTs) and their interaction with the trading infrastructure.
As part of its investigation, the AFM documented the criticisms levelled at high-frequency trading, and studied two criticised trading strategies:
- apparent liquidity: as a result of new applications of technology in the market infrastructure and at market parties, order books can change rapidly. An investor thinks he can enter into a transaction, but is unable to do so because orders seem to suddenly disappear. Investors perceive this phenomenon as apparent liquidity and blame it on the trading practices of high frequency traders. The typical trading behaviour of some high-frequency traders is to often amend or cancel orders. Such volatile orders can mislead investors. In the AFM’s point of view, the rapid and frequent amending or withdrawing of orders is an essential feature of a common earnings model known as market making; and
- liquidity spotting: another often heard criticism concerns the trading strategy of high-frequency traders in which they could predict on the basis of partial executions of orders, mostly of large investors, where liquidity will occur. According to critics, HFTs then buy or sell liquidity on other investor trading platforms pre-empting investors. HFTs can then close out the position with the original investor as counterparty at a more favourable price. Through such actions by HFTs, investors would pay more for a purchase or receive less for a sale. The AFM analysed the trading practice by HFTs in connection with the execution of five large orders on Dutch and English trading platforms. Within the Netherlands’ jurisdiction, it was not shown in these orders that HFTs were able to ‘spot’ liquidity.
View the AFM’s report containing a case analysis of critiques on high-frequency trading, 2 June 2016.