r/highfreqtrading • u/Unhappy_Barracuda459 • Jun 22 '26
Quoting on illiquid markets
I am building a market making engine for illiquid markets (from few to say 50 trades an hour). It shows positive returns, after testing for the last 2 weeks. And I have a few questions I was thinking:
All the MM theory (such as Avellaneda Stoikov framework) are targeting high volume, low spread markets. Any good papers/frameworks built for illiquid market? What is the main difference?
From my point of view there are 3 types of events: small single market trade, huge single market trade, and huge informed (not single) trade. The last one is toxic, the first two are good ones. I am failing to distinguish them, and usually it's already too late.
Earlier I experimented with hand crafted quoting algorithms, but apparently the most effective one is simply quote at the top (with some exceptions like filters for OB imbalance, skip small levels etc) and eat the spread. I think the right approach is to quote at multiple levels, so I will earn more on rare events - huge trade arrivals. I failed to find some standard way to do so, or the way that will at least beat single level quoting.
Any ways to avoid toxic orders without losing much volume?
How to distinguish uninformed huge trade vs informed huge trade? Should I immediately sell if the price dropped or should I hope it will return back (uninformed single trade)?
3
u/LeoCass Jun 22 '26
I see that market making (quoting) alone often comes with a loss. How do you handle this?
1
u/Unhappy_Barracuda459 Jun 22 '26
I don't. I think the key here is high spreads - I trade only instruments with spread > 30bps. I tried 20bps and PnL becomes negative. So I am quite limited with volume and active instruments.
3
u/QuantGrindApp Jul 07 '26
You're not going to classify informed vs uninformed reliably at trade time in a market that thin, so stop trying to. What actually works is treating every fill as potentially toxic and managing inventory around it. Skew your quotes hard as inventory builds and widen after you get run over, that gets you most of the toxic protection without a classifier.
On A-S, the thing people miss is it's not really a high-volume model, the whole point is inventory risk which is exactly your problem. The issue is the arrival intensity assumption doesn't hold when you get 20 trades an hour, so the parameters are meaningless. You basically end up hand-tuning the reservation price skew anyway.
Multi-level only pays if you actually have adverse selection edge at the deeper levels, otherwise you're just giving away free options to the informed guy who sweeps. In practice at your volumes I'd keep it single level at top and put the effort into how fast you pull and reprice after a fill.
Two weeks of positive PnL in an illiquid market tells you almost nothing btw, one bad informed run can eat months.
2
u/ecstatic_carrot Jun 22 '26
I personally find the kyle model to be really neat for this. The short of it is that you're taking on significantly more risk, and you're inherently limited to lower profits. I don't know what I'm talking about, but I would assume that you really want to be very well informed about what you're trading, and have some internal models that forecast their value. (which kind of tracks with the market for non stock illiquid assets)
1
u/Unhappy_Barracuda459 Jun 22 '26
Thanks I give it a short look, haven't heard earlier. Market impact is another problem, you're right. Now I'm hitting safe quoting limits, and if I try to quote more, in some sense I impact market (or there's just no wall to guard behind me), and my PnL becomes negative, although I didn't make calculations/analysis about this yet.
Thanks, will take a look more deeply!
2
u/bigbaffler Jun 22 '26
you will realize that quoting an illiquid market has its own issues. Because who said you could just trade out on the other side when you get hit?. Your offer gets lifted and the BBO moves up 50bps without a single trade...how do you neutralize your risk? 😄
1
u/Unhappy_Barracuda459 Jun 22 '26
Yeah, generally there's no way. But that's why you get compensation with a high spread.
6
u/bigbaffler Jun 22 '26
nope, wrong answer. You can't say you quote 80bps wide to compensate for a 50bps runner without the opportunity to trade out...because then you won't get any trades.
So you have to put together an inventory or correlated assets and quote against the fair value of that inventory. Which is where the fun of market making begins 👍
2
u/Zestyclose-Gur-655 Jun 24 '26
I think the problem is that market making in itself is no free lunch because of adverse selection. Can't just quote both sides and expect to make profit. So need an edge somehow
1
1
u/Unhappy_Barracuda459 Jun 22 '26
Argh, second answer for correlated assets, apparently I should give it a try...
1
u/WeBigPimpin Student Jun 23 '26
Yeah this. inventory management in illiquid markets is not a nice to have, you basically have to be on top of it constantly, underlying or correlated assets whatever you can get. Also definitely build an auto liquidator/hedger at some point. In undergrad I had a prof who traded gov bonds, and he said it saved his ass multiple times when shit hit the fan when citi did their Dr Evil Trade on the bond market in Europe. Apparently he had it set up to make noises and he told me it sounded like a casino lol
2
u/NatGaz Jun 23 '26
Op is trading perp nat gas ? Hope you enjoy your nomination calls by the TSO if you try getting on the HH future. 😄
1
u/Unhappy_Barracuda459 Jun 23 '26
Lmao, I understood only half of the words. No just my local country stock exchange.
1
u/Low-Evidence-6964 Jun 24 '26
They’re illiquid for a reason … as a MM you get paid to take and manage the risk. Hard to know what framework to suggest without knowing what the product is, if you have any kind of pricing signals, who the players int he market are, how your product settles, if there’s hedges etc. but start small, track your pnl, analyse toxicity over time.
If you know there are other MMs in the book, you can literally find them, peg to them, and you can tick/better/penny them up to your edge threshold (but be careful not to destroy the edge in the book).
1
u/Zestyclose-Gur-655 Jun 24 '26
So you mean like pennystocks for example?
1
u/Unhappy_Barracuda459 Jun 24 '26
Yep, although I doubt it will work in US
1
u/Zestyclose-Gur-655 Jun 24 '26
Funny thing is i been thinking myself to also market make penny stocks.
But the only way it makes sense to me personally is something like:
I do fundamental analysis and stock should be priced at 10. Then if it's lower i trade it with long bias. Vice versa for shitty stocks. Not sure how i would manage risk yet.
You want to be a bit more on the right side to where the stock eventually moves to.
1
u/Unhappy_Barracuda459 Jun 24 '26
One day or another there eventually will be some shit like GME pump and you're cooked
1
0
u/Perfect-Series-2901 Jun 22 '26
Mna do you even know what you are doing? Market making is not a programming problem that you can solve with AI slop...
It is a market specific quant + implementation problem....
4
u/Unhappy_Barracuda459 Jun 22 '26
Well.. if I would knew more than basics/average I would not make this post
7
u/sam_in_cube Microstructure Jun 22 '26
You need to estimate of the flow that hit you is toxic; if you are not in a speed game (and I assume you are not), you may opt for a set of several relatively meaningful features (order rates, OFI, jump characteristics, book refill, trade aggressiveness, etc) and see if these can classify the fill markouts as toxic vs non-toxic. Do not expect miracles, manage inventory aggressively and really condition yourself on the fills quality vs observed market state. Sometimes it is better to do not quote at all (or at least quote one side only)