Trader See, Trader Do: How Do (Small) FX Traders React to Large Counterparties’ Trades?

Abstract

We show that information about the counterparty of a trade affects the future trading decisions of individual traders. The effect is such that traders tend to reverse their order flow in line with the better-informed counterparties. Informed traders primarily incorporate their own private as well as publicly available information into prices, whereas uninformed traders mainly magnify the effect of the informed. This pattern of interaction among traders extends to different order types: traders treat their own and others’ market orders as more informative than limit orders.

Keywords: Foreign exchange microstructure, order flow, informed traders, counterparty identity

JEL Classification: F31, G12, G15, D82