Cancellations of Limit Orders

Abstract

Recent data from the NYSE shows that more than 20 percent of all the orders submitted to the SuperDot are cancellation orders. In fact, there are more cancellation orders than there are market buy orders or market sell orders. Of all the limit orders that are submitted in any particular day, 40 percent of them are cancelled by the end of the day. This paper investigates into the motivation behind these cancellations. The paper finds that order cancellation plays an important role in several trading strategies adopted by some limit order traders. These strategies are the order splitting strategy, the undercutting strategy, and the limit order replacement strategy. These three trading strategies, which involve cancellations, account for up to 85 percent of all the cancellation orders in the sample. The paper also finds that, subsequent to cancellations, limit order traders are most likely to withdraw from trading. If they choose to re-enter the market, they are most likely to resubmit the limit orders with more aggressive limit prices, than to replace the cancelled orders with market orders. The paper also shows that the decision of traders to cancel their orders is influenced by certain market and order characteristics. A limit order trader is more likely to cancel his limit buy (sell) order when there is a positive (negative) change in the bid (ask), and when there is an increase in the price of the stock, after the order is submitted. He is also more likely to cancel his limit order when the spread increases after he submits his order and as the day proceeds. However, he is less likely to cancel his orders at the last half hour of trading.