2012): “On the Dark Side of the Market: Identifying and Analyzing Hidden Order Placements,” Working Paper

Trading under limited pre-trade transparency becomes increasingly popular on financial markets. We provide first evidence on traders ’ use of (completely) hid-den orders which might be placed even inside of the (displayed) bid-ask spread. Employing TotalView-ITCH data on order messages at NASDAQ, we propose a simple method to conduct statistical inference on the location of hidden depth and to test economic hypotheses. Analyzing a wide cross-section of stocks, we show that market conditions reflected by the (visible) bid-ask spread, (visible) depth, recent price movements and trading signals significantly affect the aggressiveness of ’dark ’ liquidity supply and thus the ’hidden spread’. Our evidence suggests that traders balance hidden order placements to (i) compete for the provision of (hid-den) liquidity and (ii) protect themselves against adverse selection, front-running as well as ’hidden order detection strategies ’ used by high-frequency traders. Ac-cordingly, our results show that hidden liquidity locations are predictable given the observable state of the market