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Journal of Undergraduate Research

Keywords

liquidity, market depth, informed trading, asset markets

College

Family, Home, and Social Sciences

Department

Economics

Abstract

Hidden limit orders have been increasingly important in asset markets over the past several years. These orders are hidden in the sense that they are not displayed or announced in any way until another order is sent to the market that trades with the hidden order. Traditionally, the two major order types in asset markets are market orders and limit orders. A market order contains instructions to buy or sell a given number of shares of a specific asset immediately at the best possible price, while a limit order signals a trader’s willingness to buy (sell) a certain number of shares of a specific asset at a price no higher (lower) than a given price. Market orders are generally executed immediately, while a limit orders remain active until traded against (generally with a market order) or cancelled. For this reason, limit orders accumulate for an asset and form what is known as the limit order book. For instance the limit order book for theoretical asset XYZ could have orders to sell 100 shares at $10.01 and $10.02 and buy 100 shares at $9.99 and $9.98. If a market order to buy 200 shares hit this market, 100 shares would be bought at $10.01 per share and an additional 100 shares would be bought at $10.02 per share. However, if a hidden limit order to sell 100 shares of asset XYZ were on the book at a price of $10.00 per share, the transaction would be very different. In that case the first 100 shares would be bought a $10.00 and the second 100 at $10.01. Despite the fact that the hidden limit order does not change the way the market looks before the market order is submitted, it clearly has a large effect on the outcome. In this project we are interested in analyzing when traders would use a hidden order versus a visible order, and how other traders respond when it is revealed that hidden order is executed. An important consideration in this analysis is the set of rules markets use to determine order priority. Because we use NASDAQ data, we use their rules in our model, specifically that limit orders are given priority first based on price, then on hidden status (visible orders at the same price are prioritized over hidden orders), and finally by the time the order was placed.

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