Filtering Order Flow to Strengthen OBI Signals in BankNifty Futures

Summary

The document examines whether order-book imbalance (OBI) better tracks near-term returns after filtering orders by lifetime, number of modifications, and when modifications occur. It compares signals from the full stream of orders with signals built from the parent orders of executed trades, using tick-level data from an Indian index futures market.

It assesses the relationship through contemporaneous correlation, linear associations across discretised regimes, and Hawkes-model excitation in event time. Filters on aggregate order flow yield only modest differences from unfiltered OBI, while applying filters to executed trades’ parent orders produces a consistently stronger directional association. The analysis treats that association as a diagnostic relevant to market quality and potential regulation. It does not establish that the filtered signal is profitable, causal, or generalisable beyond the market and short horizons studied.

Key ideas

• OBI is evaluated as a directional indicator for short-horizon futures returns.
• Order lifetime and modification patterns provide structural criteria for filtering order flow.
• The analysis compares aggregate order flow with parent orders linked to executed trades.
• Three diagnostics examine correlation, regime-level association, and event-time excitation.
• Filtering aggregate flow has modest effects, while filtering executed-trade parent orders strengthens directional association.
• The results are observational and do not demonstrate profitability or causal impact.

Tags

# Order-Flow Filtration and Directional Association with Short-Horizon Returns


# Order-Flow Filtration and Directional Association with Short-Horizon Returns









Electronic markets generate dense order flow with many transient orders, which degrade directional signals derived from the limit order book (LOB). We study whether simple structural filters on order lifetime, modification count, and modification timing sharpen the association between order book imbalance (OBI) and short-horizon returns in BankNifty index futures, where unfiltered OBI is already known to be a strong short-horizon directional indicator. The efficacy of each filter is evaluated using a three-step diagnostic ladder: contemporaneous correlations, linear association between discretised regimes, and Hawkes event-time excitation between OBI and return regimes. Our results indicate that filtration of the aggregate order flow produces only modest changes relative to the unfiltered benchmark. By contrast, when filters are applied on the parent orders of executed trades, the resulting OBI series exhibits systematically stronger directional association. Motivated by recent regulatory initiatives to curb noisy order flow, we treat the association between OBI and short-horizon returns as a policy-relevant diagnostic of market quality. We then compare unfiltered and filtered OBI series, using tick-by-tick data from the National Stock Exchange of India, to infer how structural filters on the order flow affect OBI-return dynamics in an emerging market setting.

Shown in full with attribution under the source's licence. Licence: abstract CC0

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.