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Generally good article that delves into how a market maker functions. Couple points: Re EA: quoting my boss, EA isn't really a dominant thing in the market mak

by smabie 4y ago

Generally good article that delves into how a market maker functions. Couple points: Re EA: quoting my boss, EA isn't really a dominant thing in the market maker space, it's pretty much only espoused by a couple high profile individuals (mainly, SBF). Re strategy: point about how there's little strategy involved in being a market maker is off-base. Everything is ultimately strategy: do I continue to pour resources into a strategy that is losing money in the hopes of eventually seeing pnl? What markets should I focus on? What is the best use of time for each employee that maximizes pnl/head? etc etc One thing that I thought article got right is that most work involved in market making is about avoiding trades, not making them. Capturing the bid ask spread is conceptually easy. The hard part is avoiding trading with toxic counterparties. Part about put options is especially apt. Market making during a crash / recession (like right now) is especially difficult because all the non-toxic counterparties have stopped trading as much (people like to trade a lot more during a bull market than a bear one). By setting up a structure such that you profit during a crash (either by buying puts, leaning net short, or through some other method), you introduce an uncorrelated return stream that can really help.

quickthrower2 4y ago
Does a market maker consider another market maker “toxic” by your definition? I assume by “toxic” you mean too smart? Or do you mean they cheat?
- ReggieCommaRose 4y ago
  Usually too smart, on rare occasion they cheat. MMs inherently deal with information assymetry and adverse selection because they generally stand ready providing liquidity with quotes out in the world (though obviously width matters). Toxic counterparties are parties who decide to trade against you who have a better idea about “true” price than you. They might make or they might not, depends if the degree in which they’re right overcomes the spread they crossed. Other MMs can be (and often are) toxic.
  - viet1 4y ago
    or doing latency arbitrage
    - matred 4y ago
      that falls into the category of knowing the “true” price better than you do
- hackerlight 4y ago
  "Order flow toxicity is the measure of a trader's exposure to the risk that counterparties possess private information or other informational advantages." Usually, flow from other MMs isn't toxic. Toxic flow can also just be someone who's executing a very large order, even if that counterparty isn't informed. If you fill them as they are starting to work their order, you could get run over as they continue to finish that order and push the price against you.
  - smabie 4y ago
    Flow from other HFT / market makers is often very toxic. They are playing the exact the game as you.
    - hchz 4y ago
      Right, sure, and that game is not lifting the market, generally speaking.
      - smabie 4y ago
        Not aware of a market maker that also doesn't take liquidity as well. In fact, it probably would impossible to market make without also taking (you wouldn't be able to provide liquidity if your quotes were in cross with the market). That said market makers do a lot more making than taking.
      - twic 4y ago
        Other market makers are often moving away from something they've seen but you haven't yet. When whatever that is hits you, the fills you got from the other market maker will look really bad.
        matred 4y ago
        Sure, but those short-term active strategies have little impact next to what big paper will lift in major macro markets.
paulpauper 4y ago
). By setting up a structure such that you profit during a crash (either by selling puts, leaning net short, or through some other method), you introduce an uncorrelated return stream that can really help isn't selling puts directional? One strategy could be something like trying to find a way to bet on volatility but without a negative carry or at least as small as possible...this is hard to do. Taleb's universa fund tries to do this.
- deleted 4y ago
  [deleted]
- smabie 4y ago
  Sorry I meant to say buying puts (and have edited comment). Buying puts is directional and has negative carry. That's often fine because when your puts aren't making money your market making strategies should be doing well and vice versa
jefftk 4y ago
> EA isn't really a dominant thing in the market maker space The article doesn't say it's dominant, it says "There is a weirdly high overlap between quant finance and Effective Altruism in general, and between Jane Street and EA in particular (it is emphatically not 100%)" I know quite a few EAs who work or worked at Jane Street, much lower profile than SBF. What the article misses is that a lot of EAs specifically went into finance because if you're looking to earn money to donate it's one of the places you can earn the most, and not because of "where they advertise jobs" or "overlap in outlooks".

by smabie 4y ago

quickthrower2 4y ago

Does a market maker consider another market maker “toxic” by your definition? I assume by “toxic” you mean too smart? Or do you mean they cheat?

ReggieCommaRose 4y ago
Usually too smart, on rare occasion they cheat. MMs inherently deal with information assymetry and adverse selection because they generally stand ready providing liquidity with quotes out in the world (though obviously width matters). Toxic counterparties are parties who decide to trade against you who have a better idea about “true” price than you. They might make or they might not, depends if the degree in which they’re right overcomes the spread they crossed. Other MMs can be (and often are) toxic.
- viet1 4y ago
  or doing latency arbitrage
  - matred 4y ago
    that falls into the category of knowing the “true” price better than you do
hackerlight 4y ago
"Order flow toxicity is the measure of a trader's exposure to the risk that counterparties possess private information or other informational advantages." Usually, flow from other MMs isn't toxic. Toxic flow can also just be someone who's executing a very large order, even if that counterparty isn't informed. If you fill them as they are starting to work their order, you could get run over as they continue to finish that order and push the price against you.
- smabie 4y ago
  Flow from other HFT / market makers is often very toxic. They are playing the exact the game as you.
  - hchz 4y ago
    Right, sure, and that game is not lifting the market, generally speaking.
    - smabie 4y ago
      Not aware of a market maker that also doesn't take liquidity as well. In fact, it probably would impossible to market make without also taking (you wouldn't be able to provide liquidity if your quotes were in cross with the market). That said market makers do a lot more making than taking.
    - twic 4y ago
      Other market makers are often moving away from something they've seen but you haven't yet. When whatever that is hits you, the fills you got from the other market maker will look really bad.
      - matred 4y ago
        Sure, but those short-term active strategies have little impact next to what big paper will lift in major macro markets.

paulpauper 4y ago

). By setting up a structure such that you profit during a crash (either by selling puts, leaning net short, or through some other method), you introduce an uncorrelated return stream that can really help isn't selling puts directional? One strategy could be something like trying to find a way to bet on volatility but without a negative carry or at least as small as possible...this is hard to do. Taleb's universa fund tries to do this.

deleted 4y ago
[deleted]
smabie 4y ago
Sorry I meant to say buying puts (and have edited comment). Buying puts is directional and has negative carry. That's often fine because when your puts aren't making money your market making strategies should be doing well and vice versa

jefftk 4y ago

> EA isn't really a dominant thing in the market maker space The article doesn't say it's dominant, it says "There is a weirdly high overlap between quant finance and Effective Altruism in general, and between Jane Street and EA in particular (it is emphatically not 100%)" I know quite a few EAs who work or worked at Jane Street, much lower profile than SBF. What the article misses is that a lot of EAs specifically went into finance because if you're looking to earn money to donate it's one of the places you can earn the most, and not because of "where they advertise jobs" or "overlap in outlooks".