6 ms·

It doesn't really matter why anyone is in the market. The fact is that they are posting prices to the limit order book, and in doing so providing liquidity and

by gd1 14y ago

It doesn't really matter why anyone is in the market. The fact is that they are posting prices to the limit order book, and in doing so providing liquidity and accepting risk and providing a service. The only way the OP could get executed passively is by offering a price equal to or better than the market price, yes? So someone got a better price (or more liquidity at the prevailing price) by him being there. There are really only two actions in a market, providing liquidity (i.e. market-making) or taking liquidity (including arbitrageurs). Stretching the shopkeeper analogy, any time you put a price tag on an item you are taking a risk and exposing yourself. You slap a price on some bananas and then there is a tropical cyclone (it happened in Australia) and the price of bananas doubles. Someone smart swoops in (call them an arbitrageur), grabs your bananas and goes to the till and you legally have to sell them to him even though they're worth double now. You also have inventory risk, if you're holding a lot of bananas out back then there is the chance that they go rotten. Every limit order (an offer to sell, or bid to buy) has an inherent risk that you should expect to be compensated for (or you wouldn't do it), and enhances the market. The more competition amongst people posting prices the better, it just means more liquidity (you can buy or sell as many bananas as you want) and tighter prices. The liquidity taker on the other hand is all about exploiting a misprice. Say, Intel release earnings and are down 10%, but the price of the highly correlated ARM hasn't moved yet, if you are the fastest you can take advantage of some poor person who still wants to buy ARM at the same price as before this information was known. Keep in mind here, a price can move without any trades happening (or goods changing hands). The shopkeepers can whip around and change the price tag on their bananas if they are fast enough before anyone buys them. It is harder to justify the liquidity taker - what marginal advantage is there to having the price of ARM react to that news in 2 milliseconds rather than 20? They force the transmission of information yes, but why is it better to have it happen a bit marginally quicker? On the other hand, how can you have a realtime market without them? It keeps the providers on their toes, and there will always be someone fastest to react. Incidentally, providing liquidity must have been the chief function of the OP's algo - 4000 trades a day doesn't work for a liquidity taker that has to cross the spread. He isn't getting 2000 mis-price signals a day to swing at, good enough to justify crossing the spread. DAX traded 120k contracts yesterday, he would have been averaging 2-3% of daily flow.

loup-vaillant 14y ago
Okay, thanks. A few minor points. I agree that "why" doesn't matter, if you know "what". When you don't however, "why" is a useful predictor. I understand the value of arbitrage, to some extent. In its current form, it's quite heavy, but I can imagine we're better off allowing it. We should compensate for value, not for risk. The two are not always correlated. I know trading is risky, but that's not the point. If it doesn't create value, it shouldn't be compensated. And I suspect some forms of trading create little to no value at all. By itself, closing a deal doesn't mean you provided value. It means the other party thinks you provided value to them. When both parties think that, either it's a win-win situation, or someone got tricked. (Delayed bids and offerings complicate this, but it's the same principle.) If I got it right, the OP did what we could call "short term speculation". If you predict something will rise, buy from a sucker who didn't. If you predict something will fall, sell it to a sucker who didn't. And of course, pray you are not the sucker. Locally, it's totally zero-sum. Now maybe the whole system facilitates real transactions (with non-speculators) at the boundaries? But even then, for a given volume your reward doesn't seem to be proportional to your facilitation power (which I have no idea how to compute), but to how well you manage to trick your fellow traders. I very much doubt that such twisted incentives can foster a useful, let alone efficient, system.
- gd1 14y ago
  You're still missing it. Every single additional limit order in the market creates real value. If I want to buy 500 shares of company A, and one market participant is offering 250 at $10. Another is offering 250 at $11. It is going to cost me 250 x 10 + 250 x 11 = $5250. Now, the "short term speculator" you are complaining about shows up and puts his tiny little order in, he is offering 1 share at $10. Now the equation if you want to execute is 251 x 10 + 249 x 11 = $5249. He/she just saved you $1. One real dollar. As someone who wants to get a transaction done on a market, more people posting bids and offers cannot possibly hurt you. Only help you. You have the complete freedom to decide to meet their offered price, to cross the spread, to pick up that carton of milk at the 7-11 and walk to the till and make the transaction. Now maybe that little speculator who sold you the share at $10, he goes and works the bid, he advertises that he wants to buy a share at $9. Someone fills him. It take 2 minutes of trading to work to the front of the queue (easily possible with an equity). During that time, he is exposed to the risk that the stock might spike up in price, a risk you are no longer exposed to since you got your desired trade done $1 cheaper and 2 minutes ago. Then if he succeeds he makes his $1 profit. It doesn't always work - maybe 60% of the time the price ticks up and he just breaks even. He pays exchange fees and clearing on both the in and out trades too. In theory, you could get involved in all of this with your 500 share purchase. Try to work the bid, get a better price, etc... or if you cross you are effectively paying for a service. Every order posted in the market is a service. How wide are bid/offer spreads these days? How can that possibly be a bad thing?

by gd1 14y ago

loup-vaillant 14y ago

Okay, thanks. A few minor points. I agree that "why" doesn't matter, if you know "what". When you don't however, "why" is a useful predictor. I understand the value of arbitrage, to some extent. In its current form, it's quite heavy, but I can imagine we're better off allowing it. We should compensate for value, not for risk. The two are not always correlated. I know trading is risky, but that's not the point. If it doesn't create value, it shouldn't be compensated. And I suspect some forms of trading create little to no value at all. By itself, closing a deal doesn't mean you provided value. It means the other party thinks you provided value to them. When both parties think that, either it's a win-win situation, or someone got tricked. (Delayed bids and offerings complicate this, but it's the same principle.) If I got it right, the OP did what we could call "short term speculation". If you predict something will rise, buy from a sucker who didn't. If you predict something will fall, sell it to a sucker who didn't. And of course, pray you are not the sucker. Locally, it's totally zero-sum. Now maybe the whole system facilitates real transactions (with non-speculators) at the boundaries? But even then, for a given volume your reward doesn't seem to be proportional to your facilitation power (which I have no idea how to compute), but to how well you manage to trick your fellow traders. I very much doubt that such twisted incentives can foster a useful, let alone efficient, system.

gd1 14y ago
You're still missing it. Every single additional limit order in the market creates real value. If I want to buy 500 shares of company A, and one market participant is offering 250 at $10. Another is offering 250 at $11. It is going to cost me 250 x 10 + 250 x 11 = $5250. Now, the "short term speculator" you are complaining about shows up and puts his tiny little order in, he is offering 1 share at $10. Now the equation if you want to execute is 251 x 10 + 249 x 11 = $5249. He/she just saved you $1. One real dollar. As someone who wants to get a transaction done on a market, more people posting bids and offers cannot possibly hurt you. Only help you. You have the complete freedom to decide to meet their offered price, to cross the spread, to pick up that carton of milk at the 7-11 and walk to the till and make the transaction. Now maybe that little speculator who sold you the share at $10, he goes and works the bid, he advertises that he wants to buy a share at $9. Someone fills him. It take 2 minutes of trading to work to the front of the queue (easily possible with an equity). During that time, he is exposed to the risk that the stock might spike up in price, a risk you are no longer exposed to since you got your desired trade done $1 cheaper and 2 minutes ago. Then if he succeeds he makes his $1 profit. It doesn't always work - maybe 60% of the time the price ticks up and he just breaks even. He pays exchange fees and clearing on both the in and out trades too. In theory, you could get involved in all of this with your 500 share purchase. Try to work the bid, get a better price, etc... or if you cross you are effectively paying for a service. Every order posted in the market is a service. How wide are bid/offer spreads these days? How can that possibly be a bad thing?