The Evolution of Algorithmic Trading and Its Impact on Market Quality Following News Announcements

Abstract

This paper examines the changing impact of algorithmic trading (AT) on market quality in the U.S. equities market. In the past, AT faced great scrutiny for flash crashes, leading to regulatory changes. However, amidst economic crises like the 2020 COVID-19 Pandemic Recession and technological advancements like improved machine learning techniques, AT occurs in unprecedented conditions. While research on AT’s impact exists, less attention has been given to its evolving impact in recent years. This paper answers the questions: 1. Are we able to identify AT following news announcements? 2. Has the amount of AT trades following news announcements changed over time? 3. Does AT market activity change with volatility when during news announcements? 4. Has the profitability of AT during news announcements changed over time? 5. Have AT trades during times of news announcements improved in their ability to shift prices toward the true underlying value of the stock? To answer these questions, we create a model capable of identifying algorithmic traders, the price volatility around the news announcement, and the change in underlying value of the stock caused by the announcement. Furthermore, we study two types of market announcements. We study earnings reports that are released during market hours and trade and quote (TAQ) data for the releasing company’s stock, and we study FOMC Minutes announcements with TAQ data for the SPY ETF. We find that (1) AT is identified following FOMC Minutes announcements but not earnings announcements during market hours. (2) There has been an increased amount of AT both in number of market participants and dollars invested. (3) AT occurs more during times of volatile trading prices. (4) We are unable to find changes in AT profitability. (5) AT does shift prices toward the true underlying value of the stock but has not improved in doing so. These findings suggest that despite an increase in AT, its impact on market quality remains the same.