the quest for efficiency november 7, 2006 hide-and-seek in the market: placing and detecting hidden...

The Quest for Efficiency November 7, 2006

Hide-and-Seek in the Market:Placing and Detecting

Hidden Orders

Rudy De Winne(FUCaM University - Mons - Belgium)

&Catherine D’Hondt

(EDHEC Business School – Lille - France)


OUTLINE

Motivation and context

Research questions (2)

Data

Methodology and results

Conclusion


MOTIVATIONMost trading systems moved

towards greater transparency…– Automation enables the dispatching of

information in real time

– Regulation?

But the use of hidden orders becomes a widespread practice Euronext, Toronto, Sydney, Nasdaq, …


TRANSPARENCY LEVELon Euronext

What market participants see on their screens• The displayed quantities available at the

different bid and ask prices• The number of orders contributing to the

depth at a bid or ask price

What they do not see on their screens• ID codes• Hidden quantities (from iceberg orders)


RESEARCH QUESTIONS

Why do traders hide their orders ?

Pardo & Pascual (2006), Anand & Weaver (2004)

How do other traders respond to the detection of hidden depth? Griffiths, Smith, Turnbull & White (2000), Ranaldo (2004), … Do traders also use information they can infer by monitoring

LOB movements (presence of hidden orders) ?


How to guess the presence

of hidden depth?Qty Bid Bid Ask Qty Ask

400 50.00

500 49.60 52.20

250 49.50 52.30 300

300 49.30 52.60 100

300 49.00 53.00 700

52.00 300

500

H_Ask

2500

1250

0

0

1000

H_Bid

0

1100

0

1000

550

Market buy order for a quantity of 300 shares

52.00 400 ?


DATA

• Public data: orders & trades+ some additional private data

• Limit order book data:both displayed and hidden quantitiesat each limit price in the whole order book

• Sample:CAC40 stocksOctober to December 2002

(64 trading days) More than 12 million of LOB states

(continuous session)


Why Do Traders Use Hidden Orders?

Traders are more likely to hide their limit orders when the order size is large relative to the prevailing displayed depth



Market members are less likely to hide part of their own limit orders than clients because they monitor the market more actively [Anand & Weaver (2004)]



Traders tend to hide when they submit non marketable but competitive limit orders


Presence of HO at the best quote

When some hidden orders are detected at the best Bid/Ask, they are thought to be present during 9 successive states !


Our order aggressiveness classificationCategory 1: orders that consume the whole displayed depth

at the best opposite quote

Category 2: orders that consume a part of displayed depth

at the best opposite quote

Category 3: orders improving the best price on the same side

Category 4: orders increasing the depth at the best quote

Category 5: other orders

How do traders respond when

they discover hidden depth?


Methodology

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Latent equation :

Ordered response :


Aggressive orders are more frequent when bid-ask spreads are narrow [Ranaldo (2004)]

RESULTS:Order aggressiveness


The deeper the market on the same side, the more aggressive the subsequent orders.

The deeper the market on the opposite side, the less aggressive the subsequent orders.



Orders are more aggressive when hidden depthis discovered at the best opposite quote

See Pardo & Pascual (2006)




When discovering hidden orders at the best quote on the same side, members respond differently when they trade for their own account or not.


CONCLUSION Euronext members hide their limit orders when the order size is

large, the price limit is competitive and they trade for their clients.

Traders are able to infer the presence of hidden orders by monitoring LOB movements and they adapt their behavior

Traders do not associate hidden orders with informed trading (depth improvement)

Development of algorithmic trading plays a key role in detecting hidden orders

Hidden depth is important to understand traders’ behavior !

the quest for efficiency november 7, 2006 hide-and-seek in the market: placing and detecting hidden...

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