How do Normal Traders and Sharp Traders Make Profits in the Chinese Security Market?

Abstract

In this paper, we consider the strategic interaction between the normal and sharp traders in a dynamic limit-order security market and its impact on the Chinese security market at different market volatility levels. We find that when the proportion of sharp traders is less than a threshold in an order-driven market, the sharp traders who submit limit orders will get more returns than the normal traders. The participation of sharp traders in the market can increase the total social welfare of all the traders. In addition, we show that:(1) when the market volatility level is generally low, the short-term sharp traders benefit from larger volatility; (2) when the market volatility level is generally high, the insider/cheating sharp traders with high-frequent trading rather than the short-term sharp traders benefit from extreme high volatility; (3) when the market volatility level is moderate, the sharp traders can increase market liquidity.

Keywords

Sharp trader / order-driven market / limit-order market / strategic interaction

References

[1] Al-Suhaibani M, Kryzanowski L. Limit vs. market order trading on the Saudi stock market. Working Paper, 2001

[2] Avellaneda M, Stoikov S. High-frequency trading in a limit order book. Quantitative Finance, 2008, 8(3): 217-224.

[3] Bayraktar E, Ludkovski M. Liquidation in limit order books with controlled intensity. Mathematical Finance, 2014, 24(4): 627-650.

[4] Brunetti C, Buyuksahin B, Harris JH. Speculators, prices and market volatility. Working Paper, 2011

[5] Buti S, Rindi B. Undisclosed orders and optimal submission strategies in a limit order market. Journal of Financial Economics, 2013, 109(3): 797-812.

[6] Cao C, Hansch O, Wang X. The information content of an open limit-order book. Journal of Futures Markets, 2009, 29(1): 16-41.

[7] Chakravarty S. Stealth-trading: Which traders’ trades move stock prices?. Journal of Financial Economics, 2001, 61(2): 289-307.

[8] Colliard JE, Foucault T. Trading fees and efficiency in limit order markets. Review of Financial Studies, 2012, 25(11): 3389-3421.

[9] Cont R D, Larrard A. Price dynamics in a Markovian limit order market. SIAM Journal on Financial Mathematics, 2013, 4(1): 1-25.

[10] Eisler Z, Bouchaud JP, Kockelkoren J. The price impact of order book events: Market orders, limit orders and cancellations. Quantitative Finance, 2012, 12(9): 1395-1419.

[11] Foucault T. Order flow composition and trading costsin a dynamic limit order market. Journal of Financial Markets, 1999, 2(2): 99-134.

[12] Foucault T, Moinas S, Theissen E. Does anonymity matter in electronic limit order markets?. Review of Financial Studies, 2007, 20(5): 1707-1747.

[13] Goettler RL, Parlour CA, Rajan U. Equilibrium in a dynamic limit order market. The Journal of Finance, 2005, 60(5): 2149-2192.

[14] Handa P, Schwartz RA. Limit order trading. The Journal of Finance, 1996, 51(5): 1835-1861.

[15] Harris L. Optimal dynamic order submission strategies in some stylized trading problems. Financial Markets, Institutions & Instruments, 1998, 7(2): 1-76.

[16] Hautsch N, Huang R. The market impact of a limit order. Journal of Economic Dynamics and Control, 2012, 36(4): 501-522.

[17] Hoffmann P. Adynamiclimit order market with fast and slow traders. Journal of Financial Economics, 2014, 113(1): 156-169.

[18] Hollifield B, Miller RA, Sandås P. Empirical analysis of limit order markets. The Review of Economic Studies, 2004, 71(4): 1027-1063.

[19] Kakade SM, Kearns M, Mansour Y, Ortiz LE. Competitive algorithms for VWAP and limit order trading. Proceedings of the 5th ACM Conference on Electronic Commerce, 2004 189-198.

[20] Kozhan R, Salmon M. The information content of a limit order book: The case of a FX market. Journal of Financial Markets, 2012, 15(1): 1-28.

[21] Leland HE. Insider trading: Should it be prohibited?. Journal of Political Economy, 1992, 100(4): 859-887.

[22] Miller RS, Shorter G. High Frequency Trading: Overview of Recent Developments, 2016, Washington DC: Congressional Research Service

[23] Obizhaeva AA, Wang J. Optimal trading strategy and supply/demand dynamics. Journal of Financial Markets, 2013, 16(1): 1-32.

[24] Parlour CA, Seppi DJ. Limit order markets: A survey. Handbook of Financial Intermediation and Banking, 2008, 5: 63-95.

[25] Rindi B. Transparency, Liquidity and Price Formation. SSRN Electronic Journal, 2002

[26] Riordan R, Storkenmaier A, Wagener M S, Zhang S. Public information arrival: Price discovery and liquidity in electronic limit order markets. Journal of Banking & Finance, 2013, 37(4): 1148-1159.

[27] Rosu I. A dynamic model of the limit order book. Review of Financial Studies, 2009, 22(11): 4601-4641.

[28] Rosu I. Liquidity and information in order driven markets. Working Paper, 2016

[29] Sands P. Adverse selection and competitive market making: Empirical evidence from a limit order market. Review of Financial Studies, 2001, 14(3): 705-734.

[30] Su D, Fleisher BM. Risk, return and regulation in Chinese stock markets. Journal of Economics and Business, 1998, 50(3): 239-256.

[31] Subrahmanyam A. Circuit breakers and market volatility: A theoretical perspective. The Journal of Finance, 1994, 49(1): 237.

[32] Wang XL, Shi K, Fan HX. Psychological mechanisms of investorsin Chinese stock markets. Journal of Economic Psychology, 2006, 27(6): 762-780.

[33] Wang Y, Wang L. Forward-backward stochastic differential games for optimal investment and dividend problem of an insurer under model uncertainty. Applied Mathematical Modelling, 2017

[34] Yueshen BZ. Queuing uncertainty in limit order market. Working Paper, 2014

[35] Zhai J, Cao Y, Yao Y, Ding X, Li Y. Coarse and fine identification of collusive clique in financial market. Expert Systems with Applications, 2017, 69: 225-238.