Question

V. If you have order-by-order trades and quotes data of a stock, explain how you can identify each transaction as "buyer initiated order" or "seller initiated order". Ex- plain the economic implications of this identification. How do you devise a trading strategy based on the order imbalance.

Answer 1

We have order-by-order trades and quotes data of a stock.

There is one unique dataset from CBOE which is known as Chicago Board Options Exchange. It works very effectively to find out the daily trading volume of call options and put options into various categories. It easily identify whether a trade is buyer initiated or seller initiated.

Well a buyer initiated order is the order in which buyer orders and cancel the order whereas in seller initiated order order is sold by seller and is dispatched by them.

Economic implications of this identification is to analyze whether a firm need to supply more or less.

If they start making more and more goods and then If the order gets imbalanced then they may suffer a big loss. So it is important to identify both of them.

Trading strategies for order imbalance-

# cut down price

# reduce the manufacturing

# supply more when everything is balanced after sometime.