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The order-books of trading exchanges are often hidden as so-called "Dark Pools". The measure was taken to avoid apparent market manipulation strategies executed by traders back then.

Which such arbitrage/manipulation strategies are possible if the order book is public?

Explain the strategies in detail.


Hint #1: There are three example strategies in the comments below.

Hint #2: Google.

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    $\begingroup$ "List and explain at least 5 trading strategies" just sounds wrong to me. $\endgroup$ – afekz Jul 7 '15 at 8:27
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    $\begingroup$ (Consolidated) limit order books present a view on the supply/demand schedule for a stock. The more complete this view, the better short-term price forecasts can be. Leaking this information as a large-in-scale trader results in greater price impact if short-term traders are able to trade ahead of you. An alternative mental model to extracting value, to your disadvantage, from large and visible order(s): they effectively amount to a free option to someone who can bid ahead of your large bid, selling at a higher price if the market moves up or turning round and hitting your bid if not. $\endgroup$ – afekz Jul 7 '15 at 9:53
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    $\begingroup$ I thought, "share trading strategies with me" types of questions are discouraged here. $\endgroup$ – LazyCat Jul 7 '15 at 14:58
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    $\begingroup$ Order books are now mostly hidden? Could have fooled me. We process over 100GB of order book data every single day in US equities. $\endgroup$ – Louis Marascio Jul 7 '15 at 16:20
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    $\begingroup$ @emcor What's not current or real-time? $\endgroup$ – Louis Marascio Jul 9 '15 at 21:33
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A public order book gives traders information not only on the current price of a security, but also the volume and structure of the entire supply and demand schedule.

Such information can be used for arbitrage and market manipulation strategies in various ways:

  • Spoofing: Inserting a large limit order as an apparent buy or sell signal which is canceled any time before it could be executed.
  • Quote stuffing: Inserting a fast sequence of limit or market orders to give market the impression of an upcoming large movement.
  • Closing Fire: Many financial institutions use only closing prices but not intraday prices for their financial models. Hence it is possible rapidly change the closing price just before end of day if the order book is not thick enough, and there can be no further orders after this time.
  • Flashing: highspeed trading algorithms can spot a public order and then trade in advance to "ride" on its market impact. Is known to amplify market crashes from large orders.
  • Latency Arbitrage: uses price differences between exchanges and fastspeed orders to capture deviations from law of one price.
  • Machine Learning: The public orderbook and its flow of orders may be used to extract valuable information on expected price changes.
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I am not sure Dark Pools (DP) have been created to avoid "market manipulation". They have been created by firms because they found an advantage to create them (see Market Microstructure in Practice, L and Laruelle Eds.). The main reasons have been:

  • spare market fees, for DP created by brokers (like UBS MTF);
  • spare market impact, for block pools (like ITG/POSIT);
  • spare half of the bid ask spread, for DP created by market makers (like Knight Link).

Optimal trading in DP is possible, see for instance Optimal split of orders across liquidity pools: a stochastic algorithm approach, by Laruelle, Pagès and L (published in SIAM Journal on Financial Mathematics, Vol. 2 (2011), pp. 1042-1076). You can have a look at Optimal Allocation Strategies for the Dark Pool Problem, by Agarwal, Bartlett, and Dama. And to Censored exploration and the dark pool problem, by Ganchev, Nevmyvaka, Kearns, and Vaughan too.

In terms of optimal trading in orderbooks, you have few nice papers:

You will find here all that you need to build you own orderbook strategy.

I strongly suggest you have a look at other posts on Quant.SE, since you will need to understand:

EDIT: these strategies are mostly robust to gaming. As soon as you value your position in terms of price and risk (i.e. using a value function) and not relatively to the mid, it is far more difficult to game you. Of course you can suffer from adverse selection, but only conditionaly to the fact you agreed on the price with respect to an historical measure. You can add some usual anti gaming features, like not using the same quantity for each of your orders, but again if your sizes are optimized according to a sophisticated enough measure, you will never place two orders with the same size.

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  • $\begingroup$ Thank you. A simple manipulation strategy would be e.g. to set a huge limit buy order to give the market the orderbook impression that price would more likely go up in the future, and delete the buy order just before it could be executed. It would be a kind of "liquidity mirage" strategy. So I am looking more for these kind of tactics... $\endgroup$ – emcor Jul 8 '15 at 6:38
  • $\begingroup$ I'd say that's more manipulation than arbitrage though. Are you looking for orderbook manipulation or orderbook arbitrage or both? $\endgroup$ – Bob Jansen Jul 8 '15 at 9:07
  • $\begingroup$ @BobJansen Yes both would be interesting. $\endgroup$ – emcor Jul 8 '15 at 10:57
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    $\begingroup$ @emcor That's called spoofing. $\endgroup$ – Louis Marascio Jul 8 '15 at 14:45
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    $\begingroup$ This is a recent case where a Public Orderbook was moved to a Dark Pool: www.coindesk.com/bitcoin-exhange-kraken-dark-pool $\endgroup$ – emcor Jul 8 '15 at 17:51

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