Sep

6

There are two types of buy / sell orders. Market orders are orders to be executed immediately at any available price. Limit orders are orders to be executed only if the specified price or better is reached. For all practical purposes the market maker bid-ask quote can be viewed as a limit order. The combination of market buy/sell and limit buy/sell gives us a total of 4 possible orders. To that we can add the cancellation of limit orders for a total of 6 possible type of trading orders. The case of cancellation of market orders is effectively eliminated because presumably the execution occurs so fast that there is no time for a cancellation.

So the interaction of these six orders is what determines a market. For a long time little was known about the distribution and interaction of these order types. The market micro-structure was a black box to most. However some early researchers, notably Vic and M.F.M. Osborne, studied the structure of markets. Vic went so far as to examine time and quote data when it was not widely available and to get permission to analyze specialists' books on the exchange in the 1960's. The findings are outlined in Education of A Speculator. A couple of key ones are:

1. Limit orders tend to be larger than market orders.

2. Given a market ticks up or down the next different tick will tend to be in the opposite direction with odds ranging from 4:1 to 7:1.

Today markets are a bit more transparent in that the order book is often available to participants willing to pay for it. However this opens up a new dimension of deception not previously available. Many orders are large bluff orders which are immediately canceled. Other gamers will repeatedly place and cancel an order at one second intervals. First this will create an aura of flashing quotes on a real time updated quote screen. Anyone who has ever seen the mesmerizing effect of a slot machine with its myriad blinking lights will quickly get the idea. The blinking lights have replaced the old time hypnotizing effect of the mindless ticker tape forever droning on.

Another trick is when there is a fairly small order on the bid or ask side and the gamester wants to attract attention to that side of the market hoping for someone to take the limit order out. They will use the same 1 second alternating big order then cancel routine to attract the eye just to the bid or the ask side of the quote. It reminds one of the mythical seductive sirens of ancient mariners seeking to lure the traveler over to the bid or ask side simply by attracting the eye.

The net result of the greater transparency has been to increase the deceptive aspects and the gaming dimension of order analysis. In addition effective analysis of order flow is now a job for a computer. Humans simply cannot keep up with the rapid fire order placement and cancellation. Even though the analysis is more difficult now compared to when Vic did his seminal studies of order flow at least we have the data.


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