21
votes
How do firms make money from "flow trading"?
Flow trading is in spirit very similar to market making - such firms make a profit by earning a spread.
There are 3 common ways this is done. Suppose a client wants to buy 100k shares of XYZ, which ...
- 5,260
19
votes
Accepted
Backtesting Market Making Strategy or Microstructure Strategy
This is a very difficult question.
First of all you should read Almgren's slides on the topic: Using a Simulator to Develop Execution Algorithms.
First you need to backtest your strategy against a "...
- 12.5k
18
votes
Market impact, why square root?
I found this power point and this paper to be an excellent source on this topic.
Here is a quote from the paper:
A square-root singularity for small traded volumes is highly
non-trivial, and ...
- 422
13
votes
Accepted
Options Market Making Used Implied Volatility Surface
Your question is twofold
How a market maker should adjust its quotes on a vol surface with respect to his inventory?
How to adjust the vol surface when a new trade is observed on the markets?
Let me ...
- 12.5k
12
votes
Accepted
Understanding how market making helps investors
I didn't quite understand your objection.
Most theories of market making are derived from a famous paper by Jack Treynor (The Economics of the Dealer Function). In the theory, there are initially no ...
- 11.6k
11
votes
Accepted
Avellaneda -Stoikov market making model
The market-maker makes a bid-ask spread $\delta$ around the reservation price $r$. So at any time, the market-maker quotes the bid price
$$
p_b = r - \delta/2,
$$
and the ask price
$$
p_a = r + \...
- 1,034
10
votes
Accepted
Market Making Strategy to Interact with IB API
Pete's seven year old answer is just as relevant now as it was in 2011. None of the limiting factors of their API has changed since then, so this is essentially an extensive reiteration.
The ...
- 1,182
8
votes
Infinite horizon agent in Avellaneda-Stoikov model
I'm doing this from memory, but as I recall $q_{\text{max}}$ is the maximum inventory on any side that you wish to take (otherwise you might build up a huge position if you are adversely selected).
...
- 234
8
votes
Accepted
What does it mean to "calibrate vols"
You are an investment bank. You trade a multitude of vanilla and exotic options. You want to make sure the option prices you quote as a client are arbitrage-free with respect to liquid option prices ...
- 8,169
8
votes
How to identify market makers in an orderbook?
You could also look at how each price level is made up.
For example how is the 18 lot on the bid price 0.0995 collated. Is it a 5 lots, 5 lots, 7 lots and 1 lot. You can do this on certain exchanges ...
- 81
7
votes
Market impact, why square root?
My understanding (devoid of any mathematical grounding) is as follows.
v = Turnover PER UNIT TIME
n = Shares you need to execute
therefore
...
- 359
7
votes
Accepted
What is the reasoning behind 'terminal time' in market making literature?
The real reason for the literature you're seeing is that constrained optimization problems are often much easier to solve and give rise to simpler, more elegant results or tractable analytical ...
- 5,260
7
votes
Is it possible to make profit by reversing client trades for a market maker?
If you are market making equities or futures you tend to make your profits over the short term by flipping your inventory. So if I'm showing 3.00 bid at 3.01 ask on a stock I'm going to tend to flip ...
- 989
7
votes
Post Trade Analysis for Option MMs
OMMs run a position that comes from the trades that they are making throughout the day. For risk management and hedging they of course need some kind of pricing and greeks model for this overall ...
- 3,056
7
votes
Accepted
Interview Market Making Strategy
That is a very funny interview question, and I will keep my answer related to true quant finance questions about market making.
if you think about Kyle's model, that is very basic but contains the ...
- 12.5k
6
votes
Accepted
Theoretical models for options bid-ask spread?
When trading options it is most useful to think in terms of implied volatilities, rather than option prices. For vanilla options, there is a one-to-one relationship between implied volatility and ...
- 5,931
6
votes
HFT to blame for Flash Crashes?
I can't say what other HFT operations do, but I can give you a description of how our automated systems worked and that may give some insight into what goes on.
From 1999 to 2007 I ran an HFT and ...
- 1,892
6
votes
What's the rationale behind having several orders on each each side for market makers
I've read this question and the other question you asked and I hope I can help.
The important thing to realize that in any market multiple market makers operate and they are all trying to optimize ...
- 8,581
6
votes
Insoluble Enigma
Your question is too broad to give anything but a very general answer. Data mining in the raw form won't do any good. At the minimum, you will pick up thousands of spurious correlations. You cannot ...
- 4,319
6
votes
Accepted
Recommendations for a text on game theory in the context of market making?
This book sounds like exactly what you want: Gaming the Market: Applying Game Theory to Create Winning Trading Strategies by Ronald Shelton. It is written from a traders' point of view rather than a ...
- 12.7k
6
votes
Accepted
What does a electronic dealer track in a RFQ market?
Customers dont place limit orders or do they?
No, they don't. In an electronic RFQ market, the requesting participant (presumably the "customer" you are referring to) is generally not ...
- 2,657
5
votes
Accepted
HFT market-making in dark pools?
Yes, it is. There is plenty of information about it online. E.g. here's a related very recent article: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2874957, here's a link to a discussion on ...
- 1,549
5
votes
What is Toxic FX Flow debate?
The primary way ECNs determine if a liquidity taker's flow is 'toxic' or not is by looking at aftermath charts. The aftermath chart shows the average mark-to-market profit of trades done by the ...
- 415
5
votes
Backtesting Market Making Strategy or Microstructure Strategy
IMO you can't backtest a HFT strategy because you cannot account for your own queue depth, or the API lag of the exchange, and more importantly, you cannot really model informed traders very well, who ...
- 639
5
votes
Accepted
Market Making Strategy
Unfortunately, with the info given, he isn't referring to any specific MMS at all. He is actually just defining some basic properties that are pretty straight forward.
In Definition 4.0.1 & 4.0.2 ...
- 141
5
votes
Market Making Algorithm/ Strategies
Check out Avellaneda and Stoikov (2008)
They model the market maker's problem in a very neat and easy to code way. Some caveats of the model, in case you do decide to use it:
The price process is ...
5
votes
Accepted
What would be the point of Roll (1984) on measuring the effective bid-ask spread?
Yes, trades do occur within the quoted spread. This occurs often when a trade happens at another venue since that venue has a different quoted spread. It also happens at the same venue as the quoted ...
- 2,952
5
votes
Accepted
Market-maker's gain variance
The probablility of a jump of $J = \phi$. ( in either direction so I'll assume $\frac{\phi}{2} = $ probability of J and $\frac{\phi}{2} = $ probability of -J ). The probability of a jump of $0 = (1-\...
- 1,160
4
votes
Market Making Literature
they are different books for quants addressing market microstructure
The Financial Mathematics of Market Liquidity 2016, by Guéant
Algorithmic and High-Frequency Trading 2015, by Cartea, Jaimungal, ...
- 12.5k
4
votes
Backtesting Market Making Strategy or Microstructure Strategy
Just a brief remark - here's a paper you might find interesting. The authors compare "market replay" trading strategies (roughly the same as backtesting) with more sophisticated "...
- 41
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