Technology and Liquidity Provision: The Blurring of Traditional Definitions

Abstract

Limit orders are usually viewed as patiently supplying liquidity. We investigate the trading of one hundred Nasdaq-listed stocks on INET, a limit order book. In contrast to the usual view, we find that over one-third of nonmarketable limit orders are cancelled within two seconds. We investigate the role these "fleeting orders" play in the market and test specific hypotheses about their uses. We find evidence consistent with dynamic trading strategies whereby traders chase market prices or search for latent liquidity. We show that fleeting orders are a relatively recent phenomenon, and suggest that they have arisen from a combination of factors that includes improved technology, an active trading culture, market fragmentation, and an increasing utilization of latent liquidity.

Keywords: fleeting orders, INET, limit orders, ECN, trading strategies, hidden liquidity, dark liquidity, supplying liquidity, demanding liquidity, technology, active trading, market fragmentation, duration analysis, survival analysis, limit order cancellation, proportional hazards model

JEL Classification: G1