Order Flow Toxicity under the Microscope

Abstract

We empirically examine which components of modern markets’ message traffic are effective advanced indicators of impending illiquidity shortfalls. Using detailed message-level data from the National Stock Exchange (NSE) of India that flags the messages of HFTs, agency ATs, and non-ATs, we show that, after controlling for volume, volatility, and other traders’ activity, only the HFTs’ net buying pressure, computed from the inflow of both aggressive and non-aggressive orders, signals toxicity, and precedes increases in both immediacy costs and price impact in the short run. Consistent with theories of active risk management, cancellations and revision of outstanding limit orders add to the overall signaling capacity of the HFTs’ net buying pressure. Market-wide indicators of the HFTs’ net buying pressure add extra power in anticipating single-stock liquidity falls.