One wonders, too, if there are mechanical/behavioural dynamics. Are buy orders predominantly limit, and sell predominantly market? Or, if one had the data, would one find that “take-profit” sell orders on an up day tend to be limit, whereas “get-out” sell orders on a down day tend to be market? And what about stop-loss cascades?


This paper provides empirical evidence that currency stop-loss orders contribute to rapid, self-reinforcing price movements, or “price cascades.” Stop-loss orders, which instruct a dealer to buy (sell) a certain amount of currency at the market price when its price rises (falls) to a prespecified level, are a natural source of positive-feedback trading. Theoretical research on the 1987 stock market crash suggests that stop-loss orders can cause price discontinuities, which would manifest themselves as price cascades. Empirical analysis of high-frequency exchange rate movements suggests the following: (i) Exchange rate trends are unusually rapid when rates reach stop-loss order cluster points; (ii) The response to stop-loss orders is larger than the response to take-profit orders, which generate negative-feedback trading and are therefore not likely to contribute to price cascades; (iii) The response to stop-loss orders lasts longer than the response to take-profit orders. Most results are statistically significant for hours. Together, these results indicate that stop-loss orders propagate trends and are sometimes triggered in waves, contributing to price cascades. The paper also provides evidence that exchange rates respond to non-informative order flow.


Are Transactions and Market Orders More Important Than Limit Orders in the Quote Updating Process? Ron Kaniel Finance Department The Wharton School

Hong Liu The Olin School of Business Washington University

This paper details that transactions, market orders and limit orders are three major factors which affect a specialist’s information set and her inventory position. In modeling a specialist’s quote updating process, before any exclusion of any of these factors, one should first address the fundamental question of their relative importance in this process. This question, however, has received little attention both in the theoretical and empirical microstruc-ture literature. Using a simple nonparametric test we investigate the relative importance of these three factors. We demonstrate that both transactions and market orders affect the quote updating process signifcantly more than limit orders, and that transactions affect it more than market orders. Furthermore, we nd that market orders convey more information than limit orders about the value of the underlying security. These results hold even after controlling for transaction and order size.


The Limit Order Effect Juhani Linnainmaa The Anderson School at UCLA November 2005

The limit order effect is the appearance that limit order traders react quickly and incorrectly to new information. This paper combines investor trading records with limit order data to examine the importance of this effect. We show that institutions earn large trading profits by triggering households’ stale limit orders and that individuals’ passivity significantly affects inferences about their behavior. Individuals are net buyers on days when prices fall because institutions unload shares to households with market orders-and vice versa on days when prices rise. An analysis of earnings announcements shows that institutions react to announcements, triggering individuals’ limit orders: the orders executed during the first two minutes lose an average of -2.5% on the same day. Investors’ use of limit orders may help to understand many findings in the extant literature, such as individuals’ seemingly coordinated tendency to trade against short-term returns.

James Sogi observes:

Interesting that the sells tops are hidden, but the buys are shown to 5 ticks. Why is that? The finger revealed the various orders at a cheap price in the middle of the night.

Recently been missing fills on limits and the market takes off. Almost feel the need to just order at market to get a toe hold in. Not sure if this is just me or a changing market cycle?

Professor Pennington comments:

The paper by Linnainmaa is important.

The paper, from rigorous analysis of data on stock trading in the 30 biggest names of the Helsinki Stock Exchange, concludes that individual investors lose a lot of money by putting in limit orders that are far from the market. These orders become “stale”, in the author’s words, if and when news is announced, and the authors demonstrate that when such limit orders get executed, it’s bad news, on average, for whoever entered them.

Conversely, they show that market orders entered within the first 5 minutes after intra-day earnings announcements tend to make a lot of money. It’s easy to understand. An alert trader is monitoring the earnings news in real time. If a favorable report emerges, he quickly snaps up shares offered at a stale price by an individual trader who could be out playing tennis.

My bias is that limit orders are bad news, specifically limit orders entered by a trader who is not going to actively monitor the news on a minute-by-minute basis.


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