Order Flow Toxicity Measure
See: Stock Order, Flow Measure, 2010_Flash Crash.
References
2013
- http://jheusser.github.io/2013/10/13/informed-trading.html
- This article describes a frequently discussed measure of informed trading in the financial world and how it can be applied to Bitcoin data. The described technique received a lot of publicity (reuters, bloomberg, cornell, tabbforum) in the last years as some authors praised it to be a good leading indicator of financial crashes.
As Bitcoin suffers under frequent mini crashes it would be useful for traders and investors alike to have such an indicator of market distress. I implemented the technique and applied it to the aftermath of the April Bitcoin crash, the most severe crash in its history.
Information based market-making models aim to explain the bid ask spread due to asymmetric information -- some traders are better informed than others about the true value of the traded asset. Consequently, a market-maker who continuously offers bid and ask quotes has to have a buffer (the spread) which protects his quotes from being adversely selected by better informed traders. …
… A perfectly informed trader is one that only buys when an asset is undervalued and only sells when an asset is overvalued. Trading against informed traders is then a bad thing since any execution from an informed trader means you received a bad price. This is especially important when you trade with limit orders all day long at a high frequency, as market-makers do. Order flow is said to be toxic (from a liquidity provider perspective) if the people you trade against have a better idea than you about the fundamental price. Thus, it is not surprising that there is a branch of market-making research solely concerned with estimating the level of informed trading.
- This article describes a frequently discussed measure of informed trading in the financial world and how it can be applied to Bitcoin data. The described technique received a lot of publicity (reuters, bloomberg, cornell, tabbforum) in the last years as some authors praised it to be a good leading indicator of financial crashes.
2011
- (Easley et al., 2011) ⇒ David Easley, MM Lopez De Prado, and Maureen O’Hara. (2011). “The microstructure of the flash crash: Flow toxicity, liquidity crashes and the probability of informed trading.” In: Journal of Portfolio Management, 37(2).
- ABSTRACT: The ‘flash crash’ of May 6th 2010 was the second largest point swing (1,010.14 points) and the biggest one-day point decline (998.5 points) in the history of the Dow Jones Industrial Average. For a few minutes, $1 trillion in market value vanished. In this paper, we argue that the ‘flash crash’ is the result of the new dynamics at play in the current market structure. We highlight the role played by order toxicity in affecting liquidity provision, and we show that a measure of this toxicity, the Volume-Synchronized Probability of Informed Trading (VPIN)*, captures the increasing toxicity of the order flow in the hours and days prior to collapse. Since the ‘flash crash’ might have been avoided had liquidity providers remained in the marketplace, a solution is proposed in the form of a ‘VPIN contract’ which would allow them to dynamically monitor and manage their risks.