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I have always felt that equity market making was a speed game for HFTs. But recently I talked to someone on the buy side, who made a claim to the contrary. He argued that with the right market making model/strategy, you can generate good returns without having the speed advantage that HFTs have. He claims to be using a vendor product to make markets in equity.

I somehow find this hard to believe but I might be wrong. Any views on this? If this person is correct, are there any interesting research papers that would support this claim ?

edit: In addition, if speed is essential, what is the minimum latency needed to be effective at market making ?

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I've talked to someone at an HFT firm and someone at Fidelity, and both said that speed is of the essence. I can't say if your friend is right or wrong, but he seems to be the exception rather than the rule. – Elliot Jans Jan 5 '12 at 23:56
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This question suffers from the same predicament as your one on pairs trading: nobody who's found success with a particular trading strategy is going to publicly admit to it. – chrisaycock♦ Jan 8 '12 at 3:47
To nitpick, nobody who currently finds success. Revealing strategies that used to be profitable is not completely unreasonable. – Ryogi Jan 8 '12 at 5:02
@chrisaycock ... I am not asking for a market making strategy. I just want to judge how important of a factor speed is. – silencer Jan 8 '12 at 5:11

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Your friend might be right, if, for example, he was talking about making a market in a set of low liquidity stocks. But that usually requires a market-making model where you're inventorying shares, for longer periods of time, which adds risk. Returns can be 'good' though.

There are other scenarios, that are exchange-model dependent, that would also mitigate the speed advantage.

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Lower liquidity doesn't mean you don't have to be fast: if the market moves, you still want to adjust fast. Personally, I find it hard to believe, that you don't need to be fast when market making in US equities. – LazyCat Jan 6 '12 at 12:20
I suppose it comes down to how one defines 'fast' (seconds, milliseconds, microseconds, etc...). Low liquidity generally means that there are fewer trades going on. The speed necessity tends to be a result of increasing levels of competition for order flow. Low liquidity stocks typically dont have that much competition for order flow, so relative to highly liquid issues(more competition), a market maker does not have to be as fast to get the flow in an illiquid market. – glyphard Jan 9 '12 at 17:24
Still disagree: suppose you make markets on some super-illiquid stock, and keep something on the bid and ask. Now the market plummets down. Your illiquid stock is likely to follow, so you want to cancel your bid as fast as you can. If there someone who can sell you your stock between market fall and your cancel - you're screwed. – LazyCat Jan 9 '12 at 22:52
The quote moves in response to trades, or other quotes, not directly in response to moves in the market. The point I'm making is that you don't need to be 'fast' per se, you just need to be about as fast as the other market makers in your stock. That is sufficient. – glyphard Jan 12 '12 at 21:59
"you don't need to be 'fast' per se, you just need to be about as fast as the other market makers in your stock" - in practice, this will mean you'll have to about as fast as GETCO, etc = as fast as possible. – LazyCat Jan 14 '12 at 23:08
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This question is for a part answered by a recently published article:

High-Frequency Technical Trading: The Importance of Speed

This paper investigates the importance of speed for technical trading rule performance for three highly liquid ETFs listed on NASDAQ over the period January 6, 2009 up to September 30, 2009. In addition we examine the characteristics of market activity over the day and within subperiods corresponding to hours, minutes, and seconds. Speed has a clear impact on the return of technical trading rules. For strategies that yield a positive return when they experience no delay, a delay of 200 milliseconds is enough to lower performance significantly. On low volatility days this is already the case for delays larger than 50 milliseconds. In addition, the importance of speed for trading rule performance increases over time. Market activity follows a U-shape over the day with a spike at 10:00AM due to macroeconomic announcements and is characterized by periodic activity within the day, hour, minute, and second.

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This paper deals mainly with liquidity taking models, from what I can tell. It's an interesting read, none the less; however, it's more relevant to a question around alpha decay of a signal than it is to the impact of speed on the profitability of market makers. – Louis Marascio Nov 22 '12 at 16:36

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