News Trading and Speed

Abstract

We compare the optimal trading strategy of an informed speculator when he can trade ahead of incoming news (is “fast”), versus when he cannot (is “slow”). We find that speed matters: the fast speculator's trades account for a larger fraction of trading volume, and are more correlated with short‐run price changes. Nevertheless, he realizes a large fraction of his profits from trading on long‐term price changes. The fast speculator's behavior matches evidence about high‐frequency traders. We predict that stocks with more informative news are more liquid even though they attract more activity from informed high‐frequency traders.

The Economics of High-Frequency Trading: Taking Stock

“…The authors show that the net effect could go either way. Foucault, Hombert & Roşu (2016) propose a dynamic model where securities with more informative news attract more HFBs, yet the average effective spread is lower. The reason is that trading with HFBs after news imposes an adverse-selection cost on market makers, thus raising the spread, but the more informative news itself lowers the spread.…”

Rise of the Machines: Algorithmic Trading in the Foreign Exchange Market

“…In contrast to these mostly positive views on AT and price efficiency, Foucault, Hombert, and Roşu () argue that, in a world with no asymmetric information, the speed advantage of algorithmic traders would not increase the informativeness of prices but would still increase adverse selection costs. In their survey article, Biais and Woolley () point out that the potential commonality of trading actions among computers may have a negative effect on the informativeness of prices.…”

Glued to the TV: Distracted Noise Traders and Stock Market Liquidity

“…Although we are not aware of a model that captures front‐running of order flow by high‐frequency traders, Foucault, Hombert and Roşu () make related predictions. These authors develop a dynamic model in which a fast speculator (i.e., a high‐frequency trader) has advanced access to incoming public information.…”

“…In addition to his usual trading on long‐term fundamentals, this speculator trades on short‐run price changes predicted by his advance knowledge of the news. Foucault, Hombert, and Roşu () show that such news‐based trading constitutes the bulk of a speculator's trading activity, which explains why trading volume has soared with the advent of algorithmic trading. We hypothesize that a similar effect may arise when the fast speculator has advance information about imminent noise trades, rather than about imminent news.…”