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The definition of micropice is S=PaVb/(Va+Vb)+PbVa/(Va+Vb), where Pa is the ask limit-order price and Va is its volume, and similar for the bid Pb and Vb.

The typical explanation for micropice is that:relatively larger quantity of offers on the bid than on the ask indicates greater buying pressure, and the 'true' price is closer to the ask than to the bid.

But my confusion is: the bid limit-order price should be hit by the aggressive ask market-orders, so the 'true' price should still be closer to bid limit-order price if with larger quantity of offers on the bid, and this will be opposite to the definition of micropice.

Could anyone help to explain?

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  • $\begingroup$ You are right, but nobody knows if aggressive market sell or market buy orders are about to hit or not. If all we can observe is the limit order book, it makes sense to assume that the market buy/sell orders that will arrive are going to be roughly matched and use the quantities at the bid and ask to try to predict which way the price is going to go. It is only a heuristic; a big market sale can cause the price to go down even though the bid queue is much bigger than the ask queue. A comparison of the queues on both sides only tells you which side is more vulnerable, not who is going to win. $\endgroup$ – noob2 Jan 11 at 16:37
  • $\begingroup$ @noob2 Thanks. So you both agree with and disagree with the definition of microprice. But then why do people still use such definition to build their trading algorithm? $\endgroup$ – olivia Jan 12 at 2:35
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The justification for that microprice is empirical, not theoretical. In most market I can think of, most of the time, if there are more orders and more size on the bid than the ask, then it's more likely that that BBO will tick up rather than down. And the greater the imbalance, the higher the probability of an uptick (and vice-versa for downticks). For your market, you can grab some tick data to verify this. If you work in HFT, then you'll likely spend a good amount of time looking at tick data and trying to come up with a better formula than the one you describe (there are lots of ways to improve it).

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  • $\begingroup$ can you please describe one? $\endgroup$ – nimbus3000 Jan 13 at 9:56
  • $\begingroup$ An obvious improvement is to include orders deeper in the book than just the BBO. $\endgroup$ – Marc Shivers Jan 14 at 12:46
  • $\begingroup$ It add a lot to the noise, makes the output very close to useless the way I have been using it. Is it possible for you to share some insights? $\endgroup$ – nimbus3000 Jan 14 at 15:13
  • $\begingroup$ what have you tried? $\endgroup$ – Marc Shivers Jan 15 at 13:39
  • $\begingroup$ I have used top 3, 5 levels, all level on both sides of the book, a lot of noise. $\endgroup$ – nimbus3000 Jan 16 at 4:48

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