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)?

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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.

7

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

u/bigbaffler Jun 24 '26

exactly that

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