Empirical Limitations on High Frequency Trading Profitability

TL;DR

This paper empirically investigates the maximum profitability of aggressive high-frequency trading strategies, revealing modest profit estimates and highlighting the impact of execution costs and trading horizons through novel simulation methods.

Contribution

It introduces a large-scale empirical framework and novel simulation techniques to estimate the upper bounds of high-frequency trading profitability.

Findings

Maximum profits are surprisingly modest.

Execution costs significantly limit profitability.

A 'future-seeing' trader simulation provides new insights.

Abstract

Addressing the ongoing examination of high-frequency trading practices in financial markets, we report the results of an extensive empirical study estimating the maximum possible profitability of the most aggressive such practices, and arrive at figures that are surprisingly modest. By "aggressive" we mean any trading strategy exclusively employing market orders and relatively short holding periods. Our findings highlight the tension between execution costs and trading horizon confronted by high-frequency traders, and provide a controlled and large-scale empirical perspective on the high-frequency debate that has heretofore been absent. Our study employs a number of novel empirical methods, including the simulation of an "omniscient" high-frequency trader who can see the future and act accordingly.