A Warning About Market Liquidity From Interactive Brokers

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The market may be (even) more illiquid than you think.

In a stark warning to its clients, popular online brokerage Interactive Brokers has advised traders to avoid using market orders at all if possible, and alternatively, to split them up into smaller orders trading over time, something legacy sellside platforms have effectively done over the years by splitting "parent" orders into smaller, "child" orders.

In a notice, IB warns that it has "noticed that you have recently submitted Market Orders in your account(s). Please see important information below regarding this order type." It then provides the following guidance:

  • Please note that a Market Order is an instruction to trade your order at any price available in the market, subject to any additional instructions for handling/simulating the particular order type you specified and other order conditions you specify when submitting your order. A Market Order is not guaranteed a specific trade price and may trade at an undesirable price. If you would like greater control over the trade prices you receive, please submit your order using a Limit Order, which is an instruction to place your order at or better than the specified limit price, or submit an algorithmic Market Order (IBALGO).
  • In accordance with our obligations as a broker, large Market Orders may be split into smaller orders, which will be traded over time. This is designed to reduce the impact of these large orders on the market, including the impact your order has on the market price.

There are two potential implications from this: one is that the HFTs are growing restless, and are aggressively frontrunning any and all market orders, thereby inciting microvolatility once large market orders hit the tape. The second, and more troubling implication, is the implicit suggestion that even a handful of large market orders can expose just how illiquid the market truly is, once "liquidity providing" HFTs all align on the same sign of the trade to be frontrun, potentially leading to even more micro, or macro, flash crashes.

And with liquidity only set to decline over the next two trading days heading into the election, we would like to underscore IB's warning: anyone wishing to trade in or out of positions, is advised to use limit orders, even if it means leaving a few pennies on the table, as the alternative could be far less pleasant.

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