Technology and Liquidity Provision: The Blurring of Traditional Definitions

Abstract

The usual economic perspective on a limit order emphasizes its role in supplying liquidity. We investigate the trading of 300 Nasdaq-listed stocks on the Island ECN, an electronic communication network organized as a limit order book. We find that a substantial portion of the limit orders are cancelled within an extremely brief time. We term "fleeting orders" those limit order that are cancelled within two seconds of submission, and explore the role they play in trading strategies. Our principal finding is that fleeting limit orders are closer substitutes for market orders than for traditional limit orders. Our results suggest that the aim of a trader who submits a fleeting order is to demand immediacy. This contrasts with the traditional view of limit order traders as patient providers of liquidity. We hypothesize that a "new equilibrium" has arisen, driven by improved technology, the emergence of an active trading culture, and increased market fragmentation. The new environment transforms the market from one in which prices are posted (visible limit orders) into one where searches (for hidden liquidity) are needed in order to achieve better terms of trade.

Optimal order display in limit order markets with liquidity competition

“…5 An exception is Esser and Mönch (2007) who allow for market impact of passive orders on prices, but not liquidity competition. Complementing previous work on the market impact of limit orders of Hautsch and Huang (2012) we show that limit order placements primarily affect the supply side of liquidity through an increase of liquidity competition.…”

Competition in the market for NASDAQ securities

“…ECN quotes are largely determined by limit orders, some of which may not display full depth, while others may be fleeting (see, for instance, Hasbrouck and Saar, 2005) or forced to post and therefore subject to frequent cancellations. In addition, if the inside depth is low, the ECN quotes may be subject to frequent changes, as they will be quickly consumed by liquidity demanders.…”

High-Frequency Activity on NASDAQ

“…As total message activity consists for 95.2% of the message types A, F, D, and U, 57.7% of total message activity involves fleeting orders at the 100 ms level. This is considerably higher than the numbers provided by Hasbrouck and Saar (2009) who find that 11.5% of nonmarketable limit orders is fleeting at the 100 ms level for individual stocks traded on INET in October 2004. The difference is most likely caused by (1) the fact that we consider a highly liquid ETF instead of individual stocks and (2) because automated trading is much more extensive and prominent in 2009e2011 compared to 2004.…”

“…Hasbrouck and Saar (2009) introduce the notion of fleeting orders, which are nonmarketable limit orders that are canceled within a short time interval after having been submitted to the exchange. Hasbrouck and Saar (2009) document that, for a sample of 100 NASDAQ listed stocks traded on INET during October 2004, 36.7% (11.5%) of the limit orders are fleeting and get canceled within 2 seconds (100 milliseconds).…”

“…Hasbrouck and Saar (2009) introduce the notion of fleeting orders, which are nonmarketable limit orders that are canceled within a short time interval after having been submitted to the exchange. Hasbrouck and Saar (2009) document that, for a sample of 100 NASDAQ listed stocks traded on INET during October 2004, 36.7% (11.5%) of the limit orders are fleeting and get canceled within 2 seconds (100 milliseconds). On the other hand, O'Hara (2010) describes how fleeting orders (but also, for example, flash orders or "match only" orders) lead to a situation where it is no longer clear what can be considered a quote and argues for a reexamination of this basic concept.…”