Introduction

The SEC defines a market maker as a firm that stands ready to buy and sell stock  on a regular and continuous basis at a publicly quoted price. Market makers provide liquidity in financial markets, making it easy for market participants to buy or sell an instrument at any time at a reasonable price. For the purpose of this project, we are focused on market making on a limit order book (typical for stock markets, commodities markets, etc.). In this environment, market makers place “limit orders” on the order book, which are public bids and asks. Bids are resting buy orders, and asks are resting sell orders. When a trader comes to the market, they can sell their stock by filling bids or buy stock by filling asks. Remember every trade must have a buyer and a seller. A market maker profits from the “bid-ask spread”— the difference between their bid and ask. For example, if a market maker quotes 100 @ 101 (bid $100, ask $101), their profit is $1 because they buy low at $100 and sell high at $101.

High-frequency trading is a type of algorithmic trading where decisions are made by a computer and executed in a very short timeframe. As any intraday trader knows, timing is very important. The shorter your time horizon is, the more important your execution speed is. In market making, speed is very important because limit orders are vulnerable to adverse selection. Due to the high-frequency nature of today’s markets, market making algorithms must rapidly adapt to changing conditions.

Although latency is important, profitable market making in today’s markets cannot be done without a good algorithm. In this project we will learn about high-frequency market making algorithms.

Goal

The goal of this project is to explore academic literature pertaining to high-frequency market making, decipher the content of the papers, and implement the solutions concluded in the papers. The end goal is to write summaries of each paper and implement a market making algorithm using our understanding of the papers.

Papers

• Avellaneda and Stoikov - High-frequency trading in a limit order book
• Guéant, Lehalle, and Fernandez-Tapia - Dealing with the Inventory Risk
• Fushimi, Rojas, and Herman - Optimal High-Frequency Market Making
• Stoikov - The Micro-Price

Team Members

• Brian Eide (Lead)
• Andrew Mou

Our team is not looking for new members, but if you understand the math in each paper and would like to join this project, please reach out to Brian ([email protected])