The Explanatory Power of Order Imbalance Measures

In modern markets, limit order traders can no longer be characterized as passive traders, which has led some researchers to argue that limit orders, rather than trades, are the informational unit in today's markets. If this is true, measures such as order imbalance, which uses signed trades and captures the information from liquidity demanders, may not be as valid as they once were. We calculate two measures of limit order imbalance and examine the relation between limit order imbalances and returns. We find evidence that limit order imbalances explain returns, but conclude that traditional order imbalance has more explanatory power. Thus, our results suggest that limit orders have not trumped trades as the informational unit in today's markets.