Behind Stock Price Movement: Supply and Demand in Market Microstructure and Market Influence

Abstract

This article studies explanatory factors for short-term stock price movement in the U.S. equity market by exploiting the relationship among liquidity supply, liquidity demand, and market movement. Liquidity provision and taking activities at the market-microstructure level are quantitatively measured by central limit order book imbalance and trade imbalance. The authors find that a multivariate linear model, fitted on empirical results of 42 individual U.S. stocks, is able to explain up to 78% of stock movement in short time intervals, with its explanatory powers and model coefficients varying with the length of interval ranging from 30 seconds to 1 hour. This study offers insight in quantifying supply-demand dynamics in market microstructure and provides meaningful ways for trading algorithms to minimize the market impact of orders and maximize liquidity extraction.