Summary

Objective

The paper investigates the short-term effects of strategic limit order submissions in the USD/JPY and EUR/JPY foreign exchange (FX) spot markets. It examines how traders (both human and algorithmic) react to these limit orders in terms of liquidity provision and withdrawal.

Data & Methodology

• The study uses a high-frequency dataset from the Electronic Broking System (EBS) for the period 9-13 September 2010.
• The dataset includes over 1.5 million limit orders, amounting to $2 trillion in volume.
• Empirical analysis focuses on how different types of orders (size, aggressiveness, order-splitting) affect liquidity within four time windows (0.1, 1, 10, and 60 seconds).

Key Findings

1. Algorithmic Order-Splitting is Perceived as Predatory
   • Algorithmic traders use order-splitting strategies to disguise large order sizes.
   • However, these strategies do not always succeed in avoiding detection. Market participants recognize split orders and often interpret them as more information-rich and potentially predatory.
2. Limit Order Size and Price Aggressiveness Relationship is Inconsistent
   • Contrary to expectations, very large orders (≥$10 million) tend to be highly aggressive, meaning they are placed very close to or within the bid-ask spread.
   • Medium-sized orders (between $2 and $5 million) tend to be less aggressive than both small and large orders.
3. Traders React More Strongly to Orders from the Same Side of the Order Book
   • Same-side orders (buy orders reacting to buy orders, or sell orders reacting to sell orders) trigger stronger reactions than opposite-side orders.
   • This suggests that traders prioritize non-execution risk (fear of their order not being filled) over free-option risk (risk of adverse selection by informed traders).
4. Liquidity Withdrawal vs. Recovery
   • Large and aggressive orders trigger immediate liquidity withdrawal, where traders cancel their existing orders to avoid being adversely affected.
   • However, within 5-10 seconds, liquidity tends to recover, primarily driven by a reassessment of free-option risk.
5. Illusion of Liquidity in Algorithmic Markets
   • Liquidity appears to be high at first but disappears quickly as algorithmic traders remove their orders in response to large submissions.
   • This aligns with concerns that algorithmic trading can create an illusion of liquidity, where apparent market depth vanishes when volatility increases.

Relevance

• The study contributes to market microstructure research, particularly for FX trading, which remains less studied than equity markets.
• Findings are relevant for regulators, market participants, and compliance officers, given recent concerns over market manipulation and FX trading scandals.
• Highlights the need to better understand algorithmic trading dynamics in FX markets to ensure stability.

Conclusion

The study provides empirical evidence that strategic limit order submissions significantly influence liquidity. Algorithmic trading strategies such as order-splitting are widely used but often detected, leading to unintended consequences. The findings raise concerns about market fairness and stability, emphasizing the importance of monitoring high-frequency trading behaviors.

This studies was published by M. masayuki susai

https://independent.academia.edu/masayukisusai?swp=rr-ac-81436071

or

https://www.researchgate.net/profile/Masayuki-Susai

Here is a summary of the document “The Impact of Strategic Limit Order Submissions on Foreign Exchange Market Liquidity“ by Alexis Stenfors and Masayuki Susai.