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The price impact of order book event is an arxiv article which shows that, over short time intervals, price changes are mainly driven by the order flow imbalance, defined as the imbalance between the supply and demand at the best bid and ask prices.

I did not fully understand what was the order flow imbalance. It seems a wonderful tool to tell when the price movement will change significantly. Is anyone able to explain mathematically and intuitively how it works?

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    $\begingroup$ Order flow imbalance is both defined mathematically and explained in the 2nd last paragraph of page 4 of the paper you referenced. $\endgroup$ – LocalVolatility Jan 28 at 21:09
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Intuitively, if there is 10x more depth at the bid than the ask, and trades arrive at (and are sized at) random, it is 10x more likely that the price will tick up than down.

In practice, often trades do not arrive at random and in fact show strong directional auto-correlation. Moreover, the depth at the bid/ask are not static quantities, they are constantly changing.

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  • $\begingroup$ If you can integrate the formula and tell me how to use it in practice, it might be nice. :D $\endgroup$ – fgauth Jan 29 at 13:50

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