Stealth Trading Research Articles

Stealth Trading by Corporate Insiders

This paper analyzes stealth trading by corporate insiders in US equity markets. Stealth trading is the practice to break up trades into sequences of smaller trades. We find that stealth trading is pervasive and distinguish two explanations. The first argues that insiders break up trades in order to conceal private information about the fundamental value of the stock, whereas the second holds that insiders act like discretionary liquidity traders who want to reduce the tem-porary price impact from trading large stakes. We find some, but inconsistent evidence for information-based explanations, but strong and unambiguous evidence for liquidity-based ex-planations. These conclusions hold across subsamples for transactions before and after the Sarbanes-Oxley act and for NASDAQ as well as NYSE stocks.

Information and trade sizes: The case of short sales

Abstract In this study, we examine short selling of NASDAQ stocks and observe that more information about future returns is contained in small short sales than in medium-sized and large short sales, thus supporting the idea that NASDAQ short sellers stealth trade. These results are robust to different subsamples of stocks with and without tradable options and stocks that are more likely to face binding borrowing constraints. Further, these findings are contrary to the results in Boehmer, Jones, and Zhang (2008) who find that large NYSE short sales contain the most information. Combined, our study supports the idea that NASDAQ's bid test is less restricting than the NYSE's uptick rule and therefore attenuates the likelihood of stealth trading (Diether, Lee, & Werner, 2009a).

Whose Trades Convey Information? Evidence from a Cross-Section of Traders

This paper contributes empirically to our understanding of informed traders. It analyzes trad-ers' characteristics in a foreign exchange electronic limit order market via anonymous trader identities. We use six indicators of informed trading in a cross-sectional multivariate approach to identify traders with high price impact. More information is conveyed by those traders' trades which - simultaneously - use medium-sized orders (practice stealth trading), have large trading volume, are located in a financial center, trade early in the trading session, at times of wide spreads and when the order book is thin.

Whose trades convey information? Evidence from a cross-section of traders

This paper contributes empirically to our understanding of informed traders. It analyzes traders’ characteristics in a foreign exchange electronic limit order market via anonymous trader identities. We use six indicators of informed trading in a cross-sectional multivariate approach to identify traders with high price impact. More information is conveyed by those traders’ trades which—simultaneously—use medium-sized orders (practice stealth trading), have large trading volume, are located in a financial center, trade early in the trading session, at times of wide spreads and when the order book is thin.

Optimal Stealth Trading of the Insider and Expected Profit of the Mimicking Trader*

AbstractIn this paper we perform theoretical and empirical analyses on the insiders' optimal “stealth” strategy and expected profits from mimicking trading when the insiders' trading information is publicly available. When insiders select a mixed strategy of AR (1) process as the information exposure strategy in a multi‐period model, we find the optimal AR (1) coefficient that maximizes the insiders' profit is negative. Also, (1) the greater the transaction volume of mimicking traders in the market and the longer the information exposure period, the closer the optimum AR (1) coefficient becomes to −1; (2) The larger the mimicking transaction volume, the smaller the insider's profit gets; and (3) When the volume of mimicking transaction is large and the private information is not much valuable, the likelihood of loss is high. We also validate certain theoretical results of our model using publicized ownership change data of major shareholders. As a result, we find the strategic evidences in the sample of insider transactions closing within 15 trading days. Also, although mimicking traders' losses have not been reported, they can suffer losses when the private information is not much valuable and the insiders take a significant strategic action.

The Impact of Trade Characteristics on Stock Return Volatility: Evidence from the Australian Stock Exchange*

AbstractThis study examines the impact of trade characteristics on stock return volatility. Using a sample of transaction data from the Australian Stock Exchange, the trading frequency of medium sized trades is found to have the greatest impact on stock return volatility. The result lends support to the stealth trading hypothesis (Barclay and Warner, 1993). After controlling for trading frequency, the average trade size is found to have little explanatory power on price volatility. Stock return volatility is more sensitive to buyer‐initiated trades than seller‐initiated trades, especially so for buyer‐initiated medium sized trades. This finding is consistent with the assertion that information effects are stronger for buys than for sells (Chan and Lakonishok, 1993).

Autocorrelation in Daily Short-Sale Volume

This study finds evidence of autocorrelation in daily short-sale volume. The degree of autocorrelation in short volume, however, is not driven by illiquid stocks or stocks that face short-sale constraints. Contrary to prior research that suggests that autocorrelation in total trade volume is explained by the flow of information into prices, our tests show that the information contained in short sales is decreasing in the level of autocorrelation. Further, we do not find that short sellers engage in stealth trading strategies indicating that stealth trading activity is not a necessary condition for the presence of autocorrelation in trading volume.

Does Informed Trading Occur in the Options Market? Some Revealing Clues

This paper analyses the relationship between proxy variables for informed trading in the options market and a set of exogenous news variables. The aim was to test directly for the presence or absence of informed trading in the options market and for the possible impact of this trading on underlying asset prices. Our findings reveal that potential informed trading in options markets is channelled basically through out-of-the-money options, except for volatility trading which mainly involves at-the-money options because of their liquidity. In both cases, we have found evidence in favour of investors’ strategic fragmentation of transactions into intermediate size trades (stealth trading). Finally, it is shown that lack of consensus among agents also generates increased trading, particularly in out-of-the-money and at-the-money options.

Intraday Stealth Trading: Which Trades Move Prices During Periods of High Volume?

Research documents a U-shaped intraday pattern of returns (Wood et al., 1985, and Harris, 1986). This paper examines which trade sizes drive the U-shaped pattern. We find that intraday price changes from larger trades exhibit a U-shaped pattern while prices changes from smaller trades show a reverse U-shaped pattern. We argue that price changes from smaller trades are higher during the middle of the day because informed investors break up their trades in order to disguise their information (Barclay and Warner, 1993) when intraday volume is low. Price changes from larger trades are likely higher at the beginning and end of the day because high volume allows informed investors to increase their trade size without revealing their information to the market (Admati and Pfleiderer, 1988). Consistent with our argument, we find that the relation between volume and price changes is increasing across trade sizes.

Trading Frictions and Market Structure: An Empirical Analysis

Abstract: Market structure affects the informational and real frictions faced by traders in equity markets. Using bid‐ask spreads, we present evidence which suggests that while real frictions associated with the costs of supplying immediacy are less in order‐driven systems, informational frictions resulting from increased adverse selection risk are considerably higher in these markets. Firm value, transaction size and order location are all major determinants of the trading costs borne by investors. Consistent with the stealth trading hypothesis of Barclay and Warner (1993), we report that informational frictions are at their highest for medium size trades that go through the order book. Finally, while there is no doubt that the total costs of trading on order‐driven systems are lower for very liquid securities, the inherent informational inefficiencies of the trading format should not be ignored. This is particularly true for the vast majority of small to mid‐size stocks that experience infrequent trading and low transaction volume.

Liquidation in the Face of Adversity: Stealth vs. Sunshine Trading

We consider a multi-player situation in an illiquid market in which one player tries to liquidate a large portfolio in a short time span, while some competitors know of the seller's intention and try to make a profit by trading in this market over a longer time horizon. We show that the liquidity characteristics, the number of competitors in the market and their trading time horizons determine the optimal strategy for the competitors: they either provide liquidity to the seller, or they prey on her by simultaneous selling. Depending on the expected competitor behavior, it might be sensible for the seller to pre-announce a trading intention (sunshine trading) or to keep it secret (stealth trading).

Stealth Trading in Options Markets

AbstractWe investigate how price discovery occurs in the options markets through traders' trade size choice. By employing transactions data on all options traded on a sample of 100 firms, we show that informed traders fragment their orders into small (medium) trades for low (high) volume contracts. We also find that almost 60% of the price discovery occurs in the exchange with the largest market share for a given option, where informed traders favor medium size trades. Upon examining distinct option series for a given stock, we find that at-the-money calls display the highest information share.

Insider Trading in the Swiss Stock Market

The scope of offences that qualify as illegal insider trading is rather narrow in Switzerland compared to other countries. Therefore we investigate abnormal returns associated with management transactions in the Swiss stock market. We find that abnormal returns of insiders are concentrated on small firms. Trading volume affects the magnitude of abnormal returns. Evidence for the stealth trading hypothesis in the Swiss stock market is found. Furthermore, our results show that clustered transactions do not reflect stronger insider beliefs. We find no evidence for insiders exploiting news announcements. Finally, only outsiders who mimic small-volume transactions of insiders can earn abnormal returns.

Which trades move prices in emerging markets?: Evidence from China's stock market

This paper extends Barclay and Warner's [Barclay, M.J. and J.B. Warner (1993), ‘Stealth trading and volatility: which trades move prices?’, Journal of Financial Economics, vol. 34, pp. 281–306.] original work on stealth trading by analysing which trades move price for the emerging Chinese stock market. A large block trade/manipulation hypothesis is proposed in addition to the stealth and public information hypotheses examined by Barclay and Warner. Using high-frequency data the results show that while medium and large-size trades are associated with disproportionately large, overall, cumulative stock price changes, it is the large-size trades (in terms of the number of transactions) which have the largest effect on cumulative price increases. Thus, while there is some support for stealth trading in the Chinese market, there are other effects in operation such as large block trades/price manipulation.

Market Response to Listing Switch between Order-Driven Markets: Empirical Evidence of the Taiwan Stock Market

This paper examines the change in returns, trading activities, and liquidity of 43 firms that moved from the Over-The-Counter market to Taiwan Stock Exchange during 2002. Using the intraday data, our empirical results suggest that abnormal returns rise as the switching date is approaching, but these returns fall off following the switch. The up-and-down pattern in cumulative abnormal returns around the switching date can be explained by the correction-to-an-overreaction hypothesis. The light trading activities of the switching stocks over the shorter event window are due to the precaution of public investors and trading activities are aroused after the switching firms stay for a longer period of time. The width and depth of liquidity are both worse following the switch. Day trading and stealth trading provide a possible explanation for this phenomenon.

Bear in China: Which Trades Push Down the Stock Prices?

This paper considers informed traders' trading strategy in a bear market. Known as stealth trading, one strategy of informed traders' is to use medium-size trades, thus medium-size trades tend to contain more information than small- and large-size trades and to have stronger impact on stock price movement. Using the transaction data provided by CSMAR database, we document the strong pattern of stealth trading in Chinese stock market during the period of June 1, 2004 to May 31, 2005, which is: (1) an order-driven market; (2) a market that has only limit orders; (3) a bear market. The empirical results add further evidence on the stealth trading in that informed traders tend to focus their trades into medium size. The proof is: price movements are mainly due to the medium-size trades. Unlike the existing literature, we find that the pattern in bear market is highly consistent with that in a bull market. Second, we further document that the per-transaction stock price changes in different trade-size categories exhibit a clear U-shape, and only the price changes induced by medium-size trades are consistent with the market movement direction. Third, the evidence shows that the medium-size trade have stronger impact on price change in those stocks whose price movement is highly consistent with the market (in our study, it refers to those stocks with low cumulative return in the sample period). All the evidence provides supports to the stealth trading hypothesis. We further extend the realm of stealth trading hypothesis: empirical evidence proves that informed trades tend to concentrate on both medium-size trades and medium-size stocks. This is a new form of stealth trading.

The Effect of Decimalization on Trade Size and Adverse Selection Costs

Abstract: We examine adverse selection costs around NYSE decimalization. Further, we analyze the relation between adverse selection costs and trade size. We find a significant increase in the percentage adverse selection cost and a reduction in dollar adverse selection cost (percentage adverse selection multiplied by the spread) following complete decimalization on the NYSE. On estimating the adverse selection components by trade size classes, we find a decline in dollar adverse selection costs in trades of all sizes, with the strongest evidence coming from medium size trades, followed by small and large size trades. One implication of our findings is that there appears to be less stealth trading following complete decimalization and less institutional trading overall.

Which Trades Move Stock Prices in the Internet Age?

We reexamine the stealth trading hypothesis that privately informed trades concentrate their trades in medium sizes (cp. Barclay and Warner (1993) using a comprehensive transaction data set covering all Nasdaq stocks for the period from 1993 to 2003. While we find support for the hypothesis and prior empirical work in the first third of the sample period, we also document a dramatic shift of the distribution of informed trades away from medium-sized and into small-sized trades beginning around 1997, and find that since in the recent past about 70-85% of price discovery takes place via small trades. Our findings are robust with respect to the choice of methodology, i.e. weighted price contribution, information share and common factor weights. We explore two main explanations for this phenomenon, namely a) that major advances in information technology have vastly improved individual investors' access to financial information and their ability to participate in the trading process speedily and cheaply, leading to a leveling of the 'playing field' between individual and institutional traders, and b) that regulatory action such as the reduction in tick size and the introduction of the Order Handling Rules on Nasdaq with the ensuing growth in alternative trading systems have caused this change. We find much support for the second alternative, but also present some evidence in favor of the first, and how small traders may have contributed to the dramatic rise and fall of Nasdaq.

Inferring the private information content of trades: a regime‐switching approach

AbstractThis paper presents an empirical model for inferring the private information content of trades at the transaction level. The trade‐indicator model of Glosten and Harris (1988) is extended to a two‐state regime‐switching setting, and the model is estimated using tick‐by‐tick data from the New York Stock Exchange (NYSE). The specialist is found to react in accordance with the proposed model. Bid–ask quotes set after the execution of a trade reflect the conjectured information content of that particular trade. Based on the estimated model four empirical results emerge: (a) the suggested regime‐switching model fit data well; (b) the reverse J‐shaped pattern of intra‐daily quoted spreads is shown to agree with the clustering of costs incurred by the specialist through trading with better‐informed agents; (c) on average 9% of all trades are found to reveal private: information to the specialist; (d) results regarding the trading volume of informed traders support the stealth trading hypothesis suggested by Barclay and Warner (1993). Copyright © 2003 John Wiley & Sons, Ltd.

Short‐run Returns around the Trades of Corporate Insiders on the London Stock Exchange

Previous work examined the long‐run profitability of strategies mimicking the trades company directors in the shares of their own company, as a way of testing for market efficiency. The current paper examines patterns in abnormal returns in the days around these trades on the London Stock Exchange.We find movements in returns that are consistent with directors engaging in short‐term market timing. We also report that some types of trades have superior predictive content over future returns. In particular, medium‐sized trades are more informative for short‐term returns than large ones, consistent with Barclay and Warner’s (1993) ‘stealth trading’ hypothesis whereby informed traders avoid trading in blocks.Another contribution of this study is to properly adjust the abnormal return estimates for microstructure (spread) transactions costs using daily bid‐ask spread data. On a net basis, we find that abnormal returns all but disappear.