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Why do I often see some very deep limit buys and limit sells in a limit book? For instance the bid-ask may be \$39.00-39.01 but I see some bids at \$20 or even \$10 and some ask at \$60 or even \$500. What's the point of doing so? To capture some potential long-tail events?

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Queue position when the price does get there. Or if an algo goes crazy then they will get ridiculous value with those limit orders. –  user2763361 Nov 25 '13 at 7:58
    
When does the SEC steps in to "break" the trade if an algo goes crazy? What rule do they follow? –  CharlesM Nov 25 '13 at 20:33
    
Different kill switch rules for different exchanges. There is a tonne of academic research on this. Makes a good event study paper with large amounts of data! –  user2763361 Nov 26 '13 at 14:29
    
The only reason is to make money due to others' errors. Such orders are very rarely being updated or cancelled. The queue position is irrelevant in this case. –  Serg Nov 26 '13 at 17:46
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1 Answer

up vote 5 down vote accepted

I can think of 3 reasons:

1) Queue position

2) To be on the other side when an alogrithm has a disastrous error, which happens quite often on singular stocks and doesn't get reported (but someone will get fined) . I've seen cases where the price will drop over 99% almost instantaneously. For this to occur a backfiring algo will clear out the entire bid schedule, but keep issuing market orders, and a smart automated market making algo will take the other side for 1 cent.

3) To capture errors by manual traders. For example if they enter an extra zero on their limit order.

For (1) to be true, the orders must be relatively near to the insides. For example an order 8 levels above the insides is likely to be for (1) and (1) only. An order many hundreds of levels away is not due to (1) but due to other factors.

All else held equal, the probability that (2) is the reason is up to the exchange in question. Some exchanges will reverse the trades when an algo breaks down making such orders futile, others won't.

As a funny fact, I was a guy who did (3). Not an extra zero, but still an error that saw a market maker make get some free money with quotes away from the insides.

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3) how this can capture errors from manual trades? –  Svisstack Nov 26 '13 at 11:37
    
@Svisstack If they enter an extra zero on their limit order for example. –  user2763361 Nov 26 '13 at 11:37
    
1) for queueing that entity must make orders on 599.99, 599.98 and so on, because price have more priority than time –  Svisstack Nov 26 '13 at 11:38
    
@Svisstack The probability of this being the reason depends on the tick size. With the tick size you're talking about the probability would be close to zero. –  user2763361 Nov 26 '13 at 11:38
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@Svisstack 10 levels above the inside would be for queue position. 5000 levels would be something else. –  user2763361 Nov 26 '13 at 11:39
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