HFT Algo Market Making
Introduction
HFT Algo Market making is an activity whereby market makers provide liquidity to the markets by constantly quoting bids and offers for a given financial instrument (or set of instruments).
In this article, we will look at the three-step process of market making: determining or estimating the expected daily range of the stock, calculating the optimal bid/ask spread based on the expected daily range, and choosing how big position you want to take at each price. We will also discuss how to decide on your position size when market making.
HFT Algo Market making is an activity whereby market makers provide liquidity to the markets by constantly quoting bids and offers for a given financial instrument (or set of instruments).
This allows other market participants to transact in the instrument without having to find a counterparty, alleviating some of their risk. In return for providing this service, they charge a small fee known as the bid-ask spread.
Market makers are a key part of the financial markets; without them it would not be possible to provide products or services such as options, futures contracts or bonds with sufficient depth of liquidity that enables buyers and sellers to transact at all times during market hours.
Step 1 is to determine or estimate the expected daily range of the stock.
The first step is to determine or estimate the expected daily range of the stock. You can use historical data to estimate this, but it’s often easier to just look at recent price action.
The daily range is the difference between its open and close, so if a stock opens at $10 and closes at $11, its daily range is $1. It will probably make sense for you to set your expected bid/ask spread based on this daily range as well.
Step 2 is to calculate the optimal bid/ask spread based on the expected daily range.
The bid/ask spread is the difference between the price at which you can sell a stock and the price at which you can buy the same stock. It is often quoted as a percentage of the market price.
If the market for Company A’s shares is $20, you might see an ask price of $20.10 and a bid price of $20.00 (10 cents lower). The difference between these two figures is called “the spread.”
The aim here is to determine what this spread should be based on:
- expected daily range (EDR)
- volume balance across orders from buy-side and sell-side clients
Step 3 is to choose how big position you want to take at each price.
The more aggressive your strategy, the more position size you should take at each price. For example, if you are trading a highly leveraged strategy such as a spread trade, it would be prudent to start with a small position size and increase it gradually over time.
This approach helps protect against major losses due to bad luck or adverse market conditions (e.g., large changes in the underlying market). On the other hand, if you are trading heavily directional strategies like momentum or mean reversion—which rely on finding persistent trends—you’ll want to start with larger positions so that your risk is weighted squarely on your side of the trade right from the beginning and remains there until its conclusion.
The decision as to how much position size to take at each price depends on the strategy.
When you’re making bids and offers, your decision as to how much position size to take at each price depends on the strategy.
You must decide whether to take a small position at a low price, or a large position at a high price.
The decision will be based on what your risk appetite is and how much capital you have available within your firm.
Market makers provide liquidity to financial markets
As you can probably guess, market makers provide liquidity to the markets by constantly quoting bids and offers for a given financial instrument (or set of instruments). Market makers are needed to provide liquidity to the markets because, without them, it would be harder for investors to buy or sell securities. In other words, they help keep the markets liquid.
Like most forms of HFT trading, market making has been criticized by some for being reckless or dangerous. However, most people agree that market makers play an important role in keeping our financial system running smoothly; therefore we should support them instead of trying to ban their activities altogether!
Conclusion
In conclusion, market making is the process of providing liquidity to financial markets by continuously quoting bids and offers for a given financial instrument or set of instruments. Market makers derive profits from the bid/ask spread, as well as from capturing price movements with their position-taking activity. This type of trading strategy is one that every trader should be aware of and interested in learning more about.
Also Read : What is Algo Trading ?