Algorithmic and High Frequency Trading [PDF]

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Algorithmic and High Frequency Trading – Book

In many of the previous chapters, the agent made trading decisions based on three key ingredients: (i) the midprice, (ii) the arrival of incoming market orders (MOs), and (iii) the agent’s own inventory. In some cases, these state variables were supplemented by observables such as order flow (see, e.g., Section 7.3 and Chapter 9), short-term-alpha in 10.4.2, and co-integration of prices in Chapter 11, among others.

In this chapter, we investigate the role that another important state variable plays: the quoted volume order imbalance ( or simply order imbalance). This is a measure of the buy versus sell pressure on an asset and, as we will see, it contains predictive power on both the arrival rates of MOs and the direction and size of future price movements. Hence, it is an important factor to include when designing trading algorithms.