How does high-frequency trading (HFT) affect market stability?

High-frequency trading (HFT) can lead to increased market volatility and liquidity issues due to its reliance on algorithmic trading strategies, which can execute a large number of trades in fractions of a second. While HFT aims to capitalize on minute price changes and provides liquidity under normal conditions, it can also exacerbate rapid price movements. If algorithms react to market events or data at varying speeds, it may result in sudden and severe fluctuations in asset prices.

Additionally, HFT can create situations where the market depth is misleading. Traders may perceive there is more liquidity than actually exists, leading to difficulties in executing trades, especially during times of market distress. This phenomenon can amplify price swings, as the exit of algorithmic trading can be as rapid as their entry, contributing to a lack of stability in market conditions. Thus, HFT's capacity to amplify volatility and present liquidity challenges makes the identification of this choice as the correct answer clear.