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Job applicants for junior trading (market making) roles are often given similar questions. An example question might be: "Make me a market on the height of the

by smabie 6y ago

Job applicants for junior trading (market making) roles are often given similar questions. An example question might be: "Make me a market on the height of the empire state building." By this the interviewer means: what price would you buy at and what price would you sell at? So for example I might respond 1000/2000. which means I'm buying at 1000ft and selling at 2000ft. Presumably, I believe the true height is somewhere between these two numbers (ideally 1500ft), at a certain confidence level. The interviewer might ask you to quote a spread given a confidence interval. The interviewer might then lift your bid or ask and then ask you to make a new market. There's a couple factors at play here: 1. The interviewer has more information than you (presumably), so whether he bought from or sold to you is valuable information. You might want to raise your quotes if he buys in order to capitalize on the new information. 2. You want to decrease your risk. So for example if he just lifted your bid, you might want to lower your quotes: offer a lower price to buy and a lower price to sell. A good market maker capture the difference between the bid-ask spread: the price for which you buy at and the price that you sell at (like any other middle man). By lowering your quotes, you are increasing the probability that you will flatten out your risk (you are not trying to speculate on the height of the empire state building). These two things are in contention, and the interviewer wants to see how you think about it/deal with it. Also the interviewer wants to ascertain whether your confidence levels are correct over multiple questions. ie if the confidence level is 80%, then you should be wrong (true value lies outside your range) about 20% of time. It is not good to be either under or over confident. Accurately dealing with uncertainty is what they are looking for. Anyways I thought this was a very similar process that you were referring to, except you are dealing with money. Which always helps to clarify things!

rahimnathwani 6y ago
Your factor #1 above (about adverse selection through trading with a well-informed counterparty) reminded me of something I read in 'Trading and Exchanges'. The section 'The Adverse Selection Spread Component' says that dealers will set their bid/ask spreads to account for the information they will get when someone hits their bid or whatever. So they need to estimate the probability that their next trade is with an informed counterparty. If that probability is high, then they'll quote a higher spread. Conversely, if they are quoting for retail order flow, they may assume they're never dealing with informed counterparties, and can offer a tighter spread.
- smabie 6y ago
  Exactly! Being a market maker means constantly interacting with counterparties that have more information than you. In order to be successful you must utilize the core information they do not have: you are in the center of the order flow. Essentially, you must try to infer the knowledge that others possess by utilizing information about how they trade with you.
kirse 6y ago
Curious, does this confidence level factor into any sort of Kelly Criterion-type calculation for what percentage of a portfolio to risk during a given trade? What quantitative factors enable someone to calibrate their confidence level for a market making event?
hogFeast 6y ago
They still ask these questions...they were asking them in the 2000s, I actually assumed they stopped asking this stuff. They demonstrate absolutely nothing. All they test for is whether you know enough about the recruiting process to know they are going to ask you some daft question about the number of windows in a city (this is called second-level thinking, it is useful in finance, it is always interesting that ppl who work in finance don't understand that...they usually ask these questions because someone asked them at their interview). If you want to know whether someone can trade: ask them what they are trading already, and just sit them down at the desk and see what happens. Investment banks are the grade-A example of terrible/illogical hiring (although one that largely achieves the goal of hiring more people like the people who already work at investment banks). Also, thinking that you can master uncertainty isn't really the point. You can't. The whole discussion is pointless. It took me a very long time to realise that the neuralgia that people who work in finance have around uncertainty (largely a function of hiring practices at banks/educational background and including myself) was predictably profitable (the second-level thinking here is realising that someone lifting your bid/offers in a trading game doesn't represent reality because in reality, the person you are trading with under conditions of uncertainty doesn't have perfect information or even more information than you...so when uncertainty increases, the potential profit increases). Thinking that you can harness the vagaries of life and your own irrationality or poor decision-making skills is, however, common amongst people with a lot of education...and totally wrong (it is an irrational fear of uncertainty borne of a heavily structured life with prescribed questions and answers).
- smabie 6y ago
  Heh, you have some fair points and probably some good stories. Hit me up, would love to hear more.

by smabie 6y ago

rahimnathwani 6y ago

Your factor #1 above (about adverse selection through trading with a well-informed counterparty) reminded me of something I read in 'Trading and Exchanges'. The section 'The Adverse Selection Spread Component' says that dealers will set their bid/ask spreads to account for the information they will get when someone hits their bid or whatever. So they need to estimate the probability that their next trade is with an informed counterparty. If that probability is high, then they'll quote a higher spread. Conversely, if they are quoting for retail order flow, they may assume they're never dealing with informed counterparties, and can offer a tighter spread.

smabie 6y ago
Exactly! Being a market maker means constantly interacting with counterparties that have more information than you. In order to be successful you must utilize the core information they do not have: you are in the center of the order flow. Essentially, you must try to infer the knowledge that others possess by utilizing information about how they trade with you.

kirse 6y ago

Curious, does this confidence level factor into any sort of Kelly Criterion-type calculation for what percentage of a portfolio to risk during a given trade? What quantitative factors enable someone to calibrate their confidence level for a market making event?

hogFeast 6y ago

They still ask these questions...they were asking them in the 2000s, I actually assumed they stopped asking this stuff. They demonstrate absolutely nothing. All they test for is whether you know enough about the recruiting process to know they are going to ask you some daft question about the number of windows in a city (this is called second-level thinking, it is useful in finance, it is always interesting that ppl who work in finance don't understand that...they usually ask these questions because someone asked them at their interview). If you want to know whether someone can trade: ask them what they are trading already, and just sit them down at the desk and see what happens. Investment banks are the grade-A example of terrible/illogical hiring (although one that largely achieves the goal of hiring more people like the people who already work at investment banks). Also, thinking that you can master uncertainty isn't really the point. You can't. The whole discussion is pointless. It took me a very long time to realise that the neuralgia that people who work in finance have around uncertainty (largely a function of hiring practices at banks/educational background and including myself) was predictably profitable (the second-level thinking here is realising that someone lifting your bid/offers in a trading game doesn't represent reality because in reality, the person you are trading with under conditions of uncertainty doesn't have perfect information or even more information than you...so when uncertainty increases, the potential profit increases). Thinking that you can harness the vagaries of life and your own irrationality or poor decision-making skills is, however, common amongst people with a lot of education...and totally wrong (it is an irrational fear of uncertainty borne of a heavily structured life with prescribed questions and answers).

smabie 6y ago
Heh, you have some fair points and probably some good stories. Hit me up, would love to hear more.