Order Flow Toxicity under the Microscope
54 Pages Posted: 18 Nov 2019 Last revised: 1 Jul 2020
Date Written: July 1, 2020
By adverse-selecting liquidity providers, toxic order flow harms liquidity. We empirically examine which components of modern markets’ net flow of orders convey information and signal toxicity. We find that the net flow of non-marketable orders is more informative than the trade-initiator-based order imbalance. The net flow of orders by high-frequency traders (HFTs) rapidly loses information content with time aggregation. Order revisions, mostly due to HFTs, carry information beyond submissions, suggesting that the HFTs’ flickering quotes primarily reflect active risk management. Finally, only the HFTs’ net flow of orders, both aggressive and non-aggressive, signals toxicity. Our findings suggest that market authorities should track the HFTs’ net order flow to develop capable leading indicators of order flow toxicity and effective circuit breaking mechanisms.
Keywords: Order flow, toxicity, order imbalance, HFT, limit orders, market orders, cancelations, monitoring, market liquidity.
JEL Classification: G10, G11, G14, G15
Suggested Citation: Suggested Citation