Order Flow Toxicity under the Microscope

54 Pages Posted: 18 Nov 2019 Last revised: 1 Jul 2020

See all articles by David Abad

David Abad

Universidad de Alicante

Magdalena Massot

Universidad de las Islas Baleares

Samarpan Nawn

Indian Institute of Management Udaipur; CFA Institute

Roberto Pascual

Universidad de las Islas Baleares

José Yagüe

University of Murcia

Date Written: July 1, 2020

Abstract

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

Abad, David and Massot, Magdalena and Nawn, Samarpan and Pascual Gascó, Roberto and Yagüe, José, Order Flow Toxicity under the Microscope (July 1, 2020). Available at SSRN: https://ssrn.com/abstract=3474294 or http://dx.doi.org/10.2139/ssrn.3474294

David Abad

Universidad de Alicante ( email )

Campus de San Vicente
Carretera San Vicente del Raspeig
San Vicente del Raspeig, 03690
Spain

Magdalena Massot

Universidad de las Islas Baleares ( email )

Crtra. Valldemossa, km 7.5
Ed. Jovellanos
Palma de Mallorca, Illles Balears 07122
Spain
34 971 172513 (Phone)
34 971 172389 (Fax)

Samarpan Nawn

Indian Institute of Management Udaipur ( email )

Balicha
Udaipur, Rajasthan 313001
India

CFA Institute ( email )

915 East High Street
Charlottesville, VA 22902
United States

Roberto Pascual Gascó (Contact Author)

Universidad de las Islas Baleares ( email )

Ctra. de Valldemossa km 7,5
Departamento de Economia y Empresa
Palma, Baleares
Spain
+34 971 17 13 29 (Phone)
+34 971 17 23 89 (Fax)

José Yagüe

University of Murcia ( email )

Department of Management and Finance
Campus de Espinardo s/n
Murcia, 30100
Spain
+34 868883862 (Phone)
+34 868887537 (Fax)

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