What makes HFTs tick? Tick size changes and information advantage in a market with fast and slow traders

Abstract

We study the impact that two trading rule changes in the interdealer spot foreign exchange market, a reduction in the "tick size'' and a subsequent increase, had on the trading behavior of various types of market participants. We find that the most notable impact of the tick size reduction was a substantial increase in the liquidity demand of high-frequency traders (HFTs), not the decrease in their liquidity provision predicted by recent literature. We show that this change in behavior was linked to the richer information environment that arose after the tick size reduction and to the ability of faster traders to exploit it. Following the tick size decrease, and owing importantly to the increase in liquidity consumption by HFTs, the role of the spot market in price discovery dropped relative to that of the futures market. This points to the need for a balanced market ecology in financial markets where fast and slow traders coexist.