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What is the definition of price pressure and what does it imply? In a number of paper I read that the price pressure can influence the portfolio returns; can you explain why and in which way it can do that?

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If you want to learn more about price pressure, you should look after market impact of metaorders, which is a more adequate term.

Because of the microstructure (i.e. the mix of orderbboks dynamics, trading rules, participants behaviours and habits, etc), the more you buy or sell, the more you influence the price an unfavorable way (for your trades).

  • Just think about the orderbooks: you at least consume liquidity in them, pushing the price to an higher level (for a large buy order). This is instantaneous impact of an isolated (large) trade.
  • then liquidity providers come back in the book, slowly relaxing the price to its former level, except if new information changed the "latent price" (think about a fed annoucement: new information, new price).
  • but if you come back with another trade, and another, etc. You prevent the price coming back, creating transient impact.
  • of course doing this, it can be consider that you provides (or exploit) information, thus the "latent price" slowly and simultaneously glides during the trading of your large metaorder.
  • At the end of this process you stop trading and can measure your temporary impact.
  • last but not least the price relaxes at a largest time scale, leading to a situation where only the permanent impact of your trade remains in the market.

In Market Microstructure in Practice, we provide a picture of empirical market impact measured on more than 300000 metaorders (during at least 4 hours each):

enter image description here

The y-axis is the price move (expressed in a generic unit). Before 100%, note the concavity of the impact on price, after 100% of the metaorder, you can see the relaxation.

More recently a new paper provided more insight of price impact, splitting price moves between impact and investor's predictions (i.e. alpha): Market impacts and the life cycle of investors orders, by Emmanuel Bacry, Adrian Iuga, Matthieu Lasnier, Charles-Albert Lehalle.

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This is a great answer! –  olaker May 11 at 20:02
    
+1 convinces me that i need to buy your book –  user2763361 May 12 at 6:53

According to the literature in market microstructure, the price pressure is defined as "the change in price when large quantities of a security are traded". Here you can find an example of how price pressure influences the bond market and in which the authors provide a complete definition of the phaenomenon and the relative problem of the information effects. Other suggestions and help will be grateful.

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