An improved Market Making Strategy
To never quote fixed distance ever again.
The usual first model you use when doing MM is quoting a fixed distance around some sort of fair value.
This could be the midprice of a big exchange like Binance, an adjusted midprice based on some metrics like orderbook imbalance, etc.
Now there are some problems with quoting a fixed distance:
It doesn’t account for other orders:
If you quote 6bps out and there is a huge limit order at 5bps you may not get filled and it may be smarter to quote at 4bps.
It doesn’t account for volatility:
If markets are volatile then you are more likely to get filled further out in the book so why not increase your spread?
It doesn’t account for directionality of takers:
Are takers more likely to buy or sell? This will affect the rate at which we get filled on both sides.
We are gonna build a model that accounts for both of those in this article and then test it live!
For an introduction to Market Making you can check out this article:
Market Making - How to start
In the previous article we looked at TWAP and VWAP and learned why those 2 indicators are extremely important in financial markets. In this article we are gonna look at a couple of different market making models, run some simulations, learn about adverse selection, every market makers biggest fear and more!
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Table of Content
The Model
Building an Orderbook
Exchange Connection
Testing it Live
Final Remarks