Undisclosed Orders and Optimal Submission Strategies in a Dynamic Limit Order Market

Recent evidence on electronic limit order markets shows a growing use of undisclosed orders. This paper offers a theory for the optimal submission strategy in a limit order book where traders simultaneously select price, quantity and exposure, and choose among limit, market, reserve (partially undisclosed) and hidden (totally invisible) orders. Our findings show that to compete for the provision of liquidity in shallow markets relatively patient traders use reserve orders, whilst aggressive traders use hidden pegged orders to undercut depth at the top of liquid books. Undisclosed orders are effective defensive strategies against front running by parasitic traders, whereas they protect against picking-off by scalpers only in slow markets where Fill&Kill orders are not used. Finally, our results show that undisclosed orders increase market depth on the top of the book, but widen the inside spread; as a result they can benefit institutional investors but harm retail traders.