Market and limit orders and their role in the price discovery process

The information level of market participants and finally, the order types and submission mechanisms of either market or limit orders – including hidden orders, have a significant price impact. An important area in the domain of price impact research is high-frequency trading (HFT), which contrary to many opinions and controversies (e.g. the false responsibility in the Flash-Crash of 6 May 2010) may in fact have a positive effect in market efficiency. In addition, they may also reduce transaction costs (spread) as a result of, for example, better price synchronization of financial instruments across markets. Performing literature research on both theoretical and empirical studies on market and limit orders and their impact in the price discovery process, it is shown that the choice between the order types is a strategic decision – even when considering that limit orders have the most long- -term price impact. In addition, limit orders are preferred by informed traders as it limits adverse selection exposure. Similar reactions will be seen with HFT traders through limit orders aiming to reduce adverse selection risk and transaction costs, which in turn leads to an increase in transaction profits.