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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 ...
madilyn's user avatar
  • 5,240
19 votes
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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 "...
lehalle's user avatar
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17 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 ...
JoseOrtiz3's user avatar
13 votes
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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 ...
lehalle's user avatar
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12 votes
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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 ...
nbbo2's user avatar
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11 votes
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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 + \...
RRG's user avatar
  • 1,024
10 votes
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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 ...
Theodore's user avatar
  • 1,172
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). ...
cjm2671's user avatar
  • 234
8 votes
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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 ...
Daneel Olivaw's user avatar
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 ...
youtta's user avatar
  • 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 ...
hjw's user avatar
  • 359
7 votes
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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 ...
madilyn's user avatar
  • 5,240
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 ...
roz's user avatar
  • 969
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 ...
StackG's user avatar
  • 3,016
7 votes
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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 ...
lehalle's user avatar
  • 12.1k
6 votes
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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 ...
Chris Taylor's user avatar
  • 5,911
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 ...
drobertson's user avatar
  • 1,882
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 ...
Dave Harris's user avatar
  • 4,299
6 votes
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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 ...
Dimitri Vulis's user avatar
6 votes
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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 ...
databento's user avatar
  • 2,488
5 votes
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Model reference price of Limit order book

This reference price is also sometimes called intrinsic price. One of the simplest ways to improve it in regards to the mid-price (assuming you have the depth data) is the following: define a ...
Serg's user avatar
  • 1,022
5 votes
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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 ...
LazyCat's user avatar
  • 1,551
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 ...
mpeac's user avatar
  • 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 ...
wildbunny's user avatar
  • 629
5 votes
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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 ...
Vincent C.'s user avatar
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 ...
python_enthusiast's user avatar
5 votes
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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 ...
kurtosis's user avatar
  • 2,900
5 votes
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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-\...
mark leeds's user avatar
  • 1,112
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, ...
lehalle's user avatar
  • 12.1k
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 "...
BGasperov's user avatar

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