How Do Quotes and Prices Evolve Around Isolated Informed Trades?

Abstract

This article investigates the order imbalance and price behavior of trades and quotes around isolated informed trades intraday. Different patterns of order flows around informed trades are documented because of the originating stock exchange, the type of informed trader, the size of the order, and the type of the firm whose shares are traded. The informed trader acts contrarian to prior trades. Informed purchases follow price declines, and sales are after price increases. The informed trade is recognized by the market maker. The purchase is executed at a significantly higher price, while the sale is executed at a significantly lower price. Trades contain more information if the insiders are at small firms. Larger orders and orders by top executives also contain more information. The order imbalance changes around an informed trade. Orders are seller-initiated prior to the purchase and become buyer-initiated after the trade. On the other hand, the order imbalance changes from buyer- to seller-initiated right around insider sales. Reversals in order imbalance are more pronounced for informed trades in small firms, for larger trades, and by top executives. There are important policy implications of the results. The recognition of informed trades by market makers justifies more scrutiny by the Securities and Exchange Commission in order to ensure fair trading.

Keywords: informed trading, market microstructure, intraday order flows

JEL Classification: G14, D82, D83