Order Flow Toxicity under the Microscope
55 Pages Posted: 18 Nov 2019 Last revised: 13 Jan 2020
Date Written: January 12, 2020
Which components of the order flow convey information and signal toxicity? We empirically show that the net flow of non-marketable orders conveys more information than the widely used trade-initiator-based order imbalance. The net order flow by HFTs rapidly loses information content with time aggregation, consistent with these traders trading on short-lived valuable signals. Updates of standing limit orders, mostly due to HFT, carry information beyond order submissions, suggesting that HFTs’ flickering quotes primarily reflect active risk management rather than manipulative practices. Finally, we find that the HFTs’ order flow, both marketable and non-marketable, signals toxicity, while the non-HFTs’ order flow does not. We conclude that market authorities should track the HFTs’ order flow at or near the best quotes to develop effective leading indicators of order flow toxicity and circuit breaking mechanisms.
Keywords: order flow, toxicity, order imbalance, high-frequency trading, limit orders, market orders, monitoring
JEL Classification: G10, G11, G14, G15
Suggested Citation: Suggested Citation