Contents

Cover
Series
Title

Page

Copyright
Dedication
Preface
Acknowledgments
Chapter

1: How

Media,
HFT

Modern

Modern
as

Markets,

Evolution

and

Is High-Frequency

What

Do

How

Many

Those

Past

Methodology

Traders

High-Frequency
in the

Organization

from

Trading?

High-Frequency

Players

Differ

HFT

of Trading

What

Major

Markets

Traders

HFT

of This

Do?
Are

There?

Space

Book

Summary
End-of-Chapter
Chapter

Questions

2: Technological

A Brief

History

Innovations,

Systems,

and

HFT

of Hardware

Messaging
Software
Summary
End-of-Chapter
Chapter

3: Market

Types
Limit

Questions
Microstructure,

Orders,

and

Limit

Order

of Markets
Order

Books

Aggressive
Complex

versus

Passive

Execution

Orders

Trading

Hours

Modern

Microstructure:

Fragmentation

in Equities

Market

Convergence

and

Divergence

Books

Fragmentation

in Futures

Fragmentation

in Options

Fragmentation

in Forex

Fragmentation

in Fixed

Fragmentation

in Swaps

Income

Summary
End-of-Chapter
Chapter
What
How

Questions

4: High-Frequency

Data1

Is High-Frequency

Data?

Is High-Frequency

Properties

Data

Recorded?

of High-Frequency

Data

High-Frequency

Data

Are

Voluminous

High-Frequency

Data

Are

Subject

High-Frequency

Data

Are

Not

High-Frequency

Data

Are

Irregularly

Most

High-Frequency

Data

to the

Normal

Do

Not

Bid-Ask

Bounce

or Lognormal
Spaced
Contain

in Time
Buy-and-Sell

Identifiers

Summary
End-of-Chapter
Chapter

Questions

5: Trading

Overview

of Execution

Costs

Execution

Costs

Transparent
Implicit

Costs

Execution

Background

and

Estimation
Empirical

Costs
Definitions

of Market

Impact

Estimation

of Permanent

Market

Impact

Summary
End-of-Chapter
Chapter

Questions

6:

Performance

and

Capacity

Strategies
Principles
Basic

of Performance

Performance

Comparative

Ratios

Measures

Measurement

of

High-Frequency

Trading

Performance
Capacity

Attribution
Evaluation

Alpha

Decay

Summary
End-of-Chapter

Questions

Chapter

Business

Key

7: The

Processes

Financial

Market

Trading

of HFT

Markets

Economics

of High-Frequency

Suitable

for

HFT

of HFT
Participants

Summary
End-of-Chapter

Questions

Chapter

8: Statistical

Practical

Applications

Arbitrage

Strategies

of Statistical

Arbitrage

Summary
End-of-Chapter
Chapter

Questions

9: Directional

Developing
What

Trading

Directional

Constitutes

Forecasting
Tradable

an

Around

Event-Based

Events
Strategies

Event?

Methodologies
News

Application

of Event

Arbitrage

Summary
End-of-Chapter
Chapter

Questions

10:

Automated

Market

MakingNave

Introduction
Market

Making:

Simulating
Nave
Market
Profitable
Summary

Key

Principles

a Market-Making

Market-Making
Making
Market

as

Strategy

Strategies
a Service
Making

Inventory

Models

End-of-Chapter

Questions

Chapter

11:

Automated

What's

in the

Data?

Modeling

Information

Market

in Order

Making

II

Flow

Summary
End

of Chapter

Chapter

12:

Market

Crashes

Latency

Questions
Additional

HFT

Strategies,

Arbitrage

Spread

Scalping

Rebate

Capture

Quote

Matching

Layering
Ignition
Pinging/Sniping/Sniffing/Phishing
Quote

Stuffing

Spoofing
Pump-and-Dump
Machine

Learning

Summary
End-of-Chapter
Chapter
Key

Questions

13:

Regulation

Initiatives

of Regulators

Worldwide

Summary
End-of-Chapter
Chapter

Questions

14:

Measuring

Risk
HFT

Management

of HFT

Risk

Summary
End-of-Chapter
Chapter
Why

15:

Execution

Order-Routing

Questions
Minimizing
Algorithms?
Algorithms

Market

Impact

Market

Manipulation,

and

Issues

with

Advanced

Basic

Models

Models

Practical

Implementation

of Optimal

Execution

Summary
End-of-Chapter
Chapter
Model

Questions

16:

Implementation

Development

Life

System

Implementation

Testing

Trading

Systems

Summary
End-of-Chapter

Questions

About

the

Author

About

the

Web

References
Index

Site

of HFT
Cycle

Systems

Strategies

Founded

in

publishing

John

company

America,

Europe,

developing
for

1807,

in

the

and

marketing

customers'

&

Sons

United

Australia,

and

our

Wiley

print

is

the

States.

Asia,
and

oldest

With

offices

Wiley

is globally

electronic

products

professional

and

independent

personal

in

North

committed
and

to

services

knowledge

and

understanding.
The

Wiley

survived

Trading
the

series

market's

features
ever

prosperedsome

by

reinventing

basics.

novice

Whether

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For

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Cover

image:

Cover

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Crusitu
John

Copyright

2013

Published

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First

Algorithmic
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of
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to algorithmic

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Edition.

series)

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Securities.

To

my

family

PREFACE
If

hiring

activity

industries,

then

successful

activity

the

Jobs

is

Journal

there

were

Stanley

in

presidents

were

directors
presidents

were

investment

into

HFT

their

employers

in

for

is

still

comprise

HFTs

in such

Kirilenko

liquid

S&P

average

Source:

its

infancy.

60

to

500

al.,

all

the

instruments

Aldridge

(2012a)

As

(NYSE:
20

associate

To

generate

vice

executive
and

vice

warrant

the

prospective

percent

the

employees

high

returns

high-frequency

market

as

just

trading

development,

of

little

for

Morgan

development,

claim

for

account

Wall
placed

roles.

levels:

all

some

reality.

ETF

related

at

field,

in

2011).

the

for

future.

percent

as

most

example,

of

high-frequency

to

While

70

the

for

in its

levels,

expected

in

Take,

operations.

reached

traded
et

at

foreseeable

account

frequently

HFT

far

advertisements

and

strategy

in

hiring

seldom

still

(see

Figure

in

for

by

expanding

section

five

technology

HFT

clearly

the

All

sought

employees

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industry

that

2012.

were

is

Investing

candidates

needed

considerable

are

four

rapidly

today.

trading

in HFT

new

(HFT)

and

27,

sought

skills

numbers

hiring

and

sector

Money

required

Despite

traders

the

candidates

were

with

financial

high-frequency

was

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profitable
trading

November

for

operation.

the
in

on

alone

in

high-frequency

classifieds

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highest

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percent

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S&P

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of all

market

activity

500

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shows,

SPY),

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trades.

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Figure

of daily

high-frequency

participants,

Scientific

25

trading

even

in

the

traders

very
on

As

shown

remain
17

in Figure

remarkably

percent

same

of

time,

industry

any

computer

that

prepare

industry

science.

required

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highly

book

is

accurate,

and

companion

many

web

practical

examples,

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informative

book

site,

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you,

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data

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seem
to

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proficiency

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study:

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simultaneously
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computer

scientists

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institutions

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programs

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to

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updates,

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fill

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opinions

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to be

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years

number

as

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students

HFTs.

suggests

barriers

15

or specialization.

complex

and

low

in SPY

2012,

to

to HFT

operator

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A natural

trading

the

complicated

programming,

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has

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pace.

participation

in 2009

ultra-short-term

from

of HFT

allocation

deploy

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and

years.

in any

can

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SPY

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profitable

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as

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Indeed,

on

observations

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trades

levels

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average

is growing

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least

stable:

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the

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1 , the

teaching
in your

on

the

the

book

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future

true,

subject

questions

The

materials.

supply

of
and

has

you

can

find

I hope

you

find

endeavors.

ACKNOWLEDGMENTS
I am
and

extremely
insightful

balanced
to

my

Howarth,
terrific

grateful

to

suggestions,

perspective,
wise

editor
diligent

publisher

to
to

Bill

Pamela

Gaia

Falloon,

senior

my

husband
my

son

Rikhye

Henry
for

ber-patient

production
Van

for

Giessen

editor
for

tireless
for

terrific

helping
front-line

development
Vincent
making

encouragement
me

keep

edits,
editor

Nordhaus,
it all happen.

a
and

Judy
and

CHAPTER
How

Modern

Markets

Structural
fact,

change

it

is

the

leadership
(HFT)

of which

better

market

modern

past

50

HFT

umbrella.

consumer
the

a result,
the

lower

errors

order

has
as

of

the

and

more

execution,

deliver

a business

their

technology
also

are

becoming

The

lower
on

illustrate

the
1.1

the

base

Financial

of

deepening

expensive
squeezes

services
Markets

full-service

in the

the
input,

1970s,

book.

As
and

platforms

savings

from
reliability

computer

firms'

reliance

complexity
capabilities

substantial

1970s

that

this
1.1

and

of

platforms.

and

Figures

before

in
prices

higher

further,

circa

the

through

model.

landscape

under

trading

reporting

margins

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effective,

financial

without

of

over

hardware

escalating

advanced

overview

2 of this

made

data

traders

technology

cost

business

The

more

traditional

financial

for

in

become

and

stability,

for

falling

Additionally,

systems.

prohibitively

pressure

in Chapter

continuity

requires

cost

in detail

has

market

the

and

markets,

markets

drops

has

years

the

computer

the

trading

costs

significant

powerful.

case

higher

strategies

for

software

If

drive

few
to

securities

demand

transmission
and

past

provides

core

trading
into

helped

execution

book

and

to

the

volatility,

the

HFT

led

has

in the

discussed

in message

regulations

Figure

decades,

investment

accessible

on

two

that

instruments.

High-frequency

lower

precipitated

defines

financial

improvements

and

and

in

over

in lower

technology-enabled

ensuing

code,

that

board,

more

of

limelight

chapter

markets

across

the

operational

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past

trading

institutions.

transparency,

years,

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to

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innovation

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financial
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stepped

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has

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Electronization

puts
1.2

Figure

1.2

Financial

Markets

Today

In

the

and

1970s

and

individuals

shows,

on

earlier,
now

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the

market

considered

portfolio

participants

were

traditional

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organizations

players.

or

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side,

Figure
the

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markets

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funds,

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Figure
and

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science

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CHAPTER

Technological

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offer

liquidity.

2,

orders,

on

the
may

of

amounting

to

suppliers

whether

takers

readily

addition

for

exchange

pay

payments,

In

pricing

the

or

of exchanges

exchanges.

divergent

1 or

Such
as

of

Depending

model
limit

models

translate

clearing
of

liquidity

to negative

in

transaction

new

takers

the

providers

bringing

the

exchanges

and

follows

liquidity
for

fees,

liquidity

exchange

pay

into

of

business
for

posting

market

costs,

orders.

are

known

rebates.

The

two

two

distinct

their

different

fee

normal
away

camps,
structure.

liquidity,

market

order,

100-share

limit

determined

by

higher

the

displayed
3.6

and

pays

the

Fee

on

Source:

NYSE

web

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higher

May

14,

site

of

exact

placing

2012,
Orders

volume

is shown
Placed

$0.13

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the

on

following

fees:

orders,

taking

bringing

for

to

$0.20

NYSE
of

NYSE

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in

100-share
for

rebate

the

in Figure
and

into

based

orders,

$0.21

of

rebate.

the

limit

from
value

exchanges

market

charges

monthly
the

offer

placing

anywhere

the

NYSE

for

example,

aggregate

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for

the

exchanges,

exchanges

rebates

for

driven

inverted

traders

offer

order.

have

and

normal

NYSE,

volume,
online

normal

charge
and

The

models

The

exchanges

liquidity.

Figure

business

is

traderthe
fee

structure

3.6 .
to

and

from

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contrast,

rebates

the

to remove

place

limit

example
for
while

traders
are

under

share.

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25,000
large

25,000

shares

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per

BX

Figure
Source:

as
3.7

per
share.

of October
Fees

Nasdaq

on
web

per

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per

day

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is shown

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million

moreare

BX,

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an

orders

or more

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3.7 .

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orders
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per
limit

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of

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rebates

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is

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to

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rates

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exchanges

regulatory

exchanges

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well

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of

to

able

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the

relationship

market

share

rates.

average
share
Figure
Source:

have

the

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of

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displays

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framework

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between

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highest

shown

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NBBO
the

divergence

various

exchanges

their

Availability

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of NBBO

Securities

(2011)

versus

of

of NBBO

and

Share

Volume

quotes

Figure
rates

and
obtain

as
the

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share.

3.8 , Nasdaq

books

suggest,

availability

of trades.
3.8

order

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market

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in Figure

availability

pricing

occurrence

highest
the

on

intuition

highest
the

and

and

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on

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all

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or

illustrates

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volume

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offers

inverted

on

and

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EDGA,

NBBO

is available

the

trading

volume

with

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order

advantage

for

Figure

3.9

When

NBBO

Source:

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inverted

the
of

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the

exchange,

contributions

to the

bottom

normal

inverted

and

flow.

parent

company

Trades

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high

BYX,

like

smaller

fees

and

available

solely

to

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structure.
BYX,

NYSE,

BX

every

(BYX).

fee

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and

EDGA,

although

Nasdaq

economic

structures

trade

structure

moves

BX,

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of

at

incentives

clearly
creates

work:
the

the

first-taker

of BX.
at

Each

Trading

Venue

Venues

(2011)

of

of

the

by

at Certain

Securities

for

to

the

enjoyed

share

profitability

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low

ask

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is not
share

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on

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much

except

best

fee

orders,

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normal

the

liquidity.

market

price

flow

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market

the

percent

on

with

available

percent

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but

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inverted

limit

BATS

from

Nasdaq,

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the

is

30

NBBO

NBBO

everywhere

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bid

the

with

moves

best

where

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exchange

the

associated

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NBBO

BX,

structure,

the

the

over

liquidity.

an

also

to

the

seeking

has

fee

removing

BATS

BX

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for

and

the

when

exchanges,

traders

for

rebates

Edge's

all

at

order

trades

BX

on

executed

except

number
BX,

what

trades

does
as

line

exchanges

not

other

of the

fees

alone
can

exchanges.

charge

traders'

contribute
provide
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to
significant

example,

fees

the

for

both
routing

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to

the

other

current

trading
exchange.

proportion

of

orders

and

can

charging

fees

exchanhes,

but

time

the

rebate

this

been

even

remain
for

the

NBBO
an

not

available

exchange

profitable

routing

is

by

with

lowest

attracting

said

orders

elsewhere.

manner

similar

on

enough

in Futures
exchanges

the

when

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NBBO

Fragmentation
Futures

venues

operated

without

book

rebate

was

structure

operational

draw

the

written.

exchanges

risk

management

circuit

breakers

and

so

liquidity,

futures

matching,

sprung

up

unlike
have

earlier.

decisions,
described

at

and

Other

predominantly

on,

equity

exchanges

discussed
are

to

or foreseeable

to attract

equities,

futures
and

implemented

In a bid
in

pro-rata

among

their

pricing

prevalent

deploying

differences

in

based

such
in

as

detail

on

when

in

to

Chapter

13.
Fragmentation

in Options

Various

options

exchanges

majority

of the

exchanges,

are

driven

Due

to

and

strike

price

10

or so

same

the

options
The

by

the

with
lack

for

option

market

price

special

knowledge,

customers.

underlying
not

yet

different
are

A
and

options

trading

large

price

usually

on

away

from

the

a bet

rest

most

enables
in

represents

dates

traded.

trade

far

to the

expiration

liquidity

common.

revealed

decade.

principles

barely

being

strike

past

of the

equity

market
long-dated

the
on

The

current

someone's

markets.

in Forex
interdealer

access

Currenex

similar

to provide

information.
with

of the

in

on

options

spreads

activity

insider

or

Fragmentation

large

of

with

most
tend

the

makers.

options

combinations,

option

direct

of

over

operate

of market

broker-dealers

relative

In Forex,

group

number

markets,

an

however,

same

sheer

surveillance

have

to

and

brokers
end

iCAP,
In

begin

traders.
for

breaking

example,
with

competing

The

with

traditionally
now

other

accept
exchanges,

broker-dealers
interdealer

selected
iCAP

for
brokers

institutional
offers

250-microsecond
exchange

validity

(forex)

Fragmentation
While

fixed

to a potential
Thus,
using

the

target

income

has
Nasdaq

in Swaps
also

trading

venues,

(SEFs),

was

book

the

and

launch

by

jointly

The

traded

Act,

shaped

by

the

offering

with

would

industry

and

further

validity

of

all

negotiated

required

to

be

A new

class

of

exchanges.
swaps

engine

privately
are

as

market.

matching

swaps

on

point

fixed-income

iCAP

OTC,

known

signs

a one-second

electronically

collectively

was

foreign

some

a fixed-income

Dodd-Frank

traded

OTC,

of the

providing

traditionally

Under

standardized

top-of-the-book

traded

technology.

investors

Fragmentation

contracts.

to

OMX

quotes.

have

its

exchange-ization

top-of-the-book

this

traditionally

planned

institutional

Swaps

of

Income

near-term

iCAP

all

quotes.
in Fixed

most

on

execution
regulators

facilities
at the

time

written.

Summary
Modern

markets

streamlining

their

immediate,

and

systems.

has

and

delivering

to the

innovation

and

of

and

the

driver

offerings,

key

the

solutions

trading

products

with

the

The

evolution

exchanges

remains

concerned

most

competition
in methods,

alternative

trading

in development

are

becoming

customized

of
more

to

clients'

needs.

End-of-Chapter
What

of

customers.

producing

execution

goal

to their

models

leaner

the

ever

service

technology

customer-centric,

1.

with

led

service

While

businesses

operations

venues

pricing,

unique

complex

cost-effective

of trading

faster

are

Questions
is

the

difference

between

the

normal

to buy

a large

and

inverted

exchanges?
2. What

type

3.

are

You

liquidation

of orders
given

(selling)

the
of

would
task
a large

you
of

use

developing

equity

position.

an

quantity?

algorithm

Your

aim

Why?
optimizing

is to

develop

an

algorithm

of

liquidation

giving

that

maximizes

process.

normal

execution

How

and

would

inverted

costs
you

price

while

minimizing

develop

such

structures

of

speed

an

algorithm

modern

equity

a certain

futures

exchanges?
4.

You

are

contract

receiving

from

liquidity

contracts.

The

reported

next

13:45:00:01:075
following

tick
with

market

from

5.

current

The

stock

on

Ask:
What

as

35.67?

6. Is an
7.

The

The
a

At

at the

bid

data

given

size

last

of 250

of

per

share

order

passive

best
to

buy

bid

limit

the

best

bid

happened

in

the

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book

are

for

likely

shares

particular

Bid

Best
at

to receive

Best

is 35.65

information:
100

National

Bid

GMT?

following

you

of

at 12.7962.

citing

has

order

at 35.68,

if the

35.69.
on

your

is advertised

instead?

or aggressive?
price

is 2.65
10

quote

325

a timestamp

contracts

What

the

shares

National

trade

the

200

shares

with

of 900

the

comprises

to 13:45:00:01:095

shows

if the

recorded

order

side

price

print

contracts.

GMT,

of 12.7962

GMT

GMT

exchange

order

iceberg

a trade

on

13:45:00:01:060

is a trade

of 325

at 35.67,

What

best

recording

right-hand

prevailing

limit

the

average

buy

II data

is a 13:45:00:01:095

shares

is the

market

of

Level

exchange.

13:45:00:01:060

100

tick

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of 12.7962

I and

a well-known

aggregate

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in

and

a given
the

contracts

at

options

prevailing
2.85

market

is

ask

is 2.90.

best

passive

or

2.83.

aggressive?

Why?
8.

A quantitative

researcher

using

daily

closing

trader

use

to execute

prices.
the

(quant)
What
quant's

develops
order

types

buy-and-sell

his

investing

should
decisions?

an

models
execution

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CHAPTER

High-Frequency
Trade

Data

and

formats.
best

quote

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time

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s units

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data,

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counterparts.

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ticker

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trade

methodologies

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a so-called

last

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short-sale
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4.3

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on

illustrates,

all

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the

recorded
average

statistics
for

SPY

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on

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duration

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the

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longest

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4.3

market

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13,

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variation

several

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trading

traders.

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liquidity

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addition

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4.11

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Figure

4.11

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using

trades.
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past

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five

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8.2

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and
index,

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are

developed

nonprofit
for

example,

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private
is
(ICSC)

by

research

companies.
calculated
and

The
by

is

the

actively

supported
tracks

and
weekly

consumer

promoted
sales

by

the

at sample

confidence:

the

Goldman

retailers

more

and

their

future

spending

and

the

higher

is

the

aspects

of

economic

different

prices

of McDonald's

and

earnings

hamburgers

in different
levels.

Table

an

schedule

shows

announcements

for

European

news

European

trading

Most

most

session

are
that

Australia
hours

in Asia.

Table

9.2

March

3, 2009

New

Ex-Ante

North

distributed

in
with

the

the

Zealand,

are

Schedule

of

the

of

released

the

trading

Pacific

in

region,
during

Macroeconomic

retail
indices

from

relative

to oil

supplies

news

trading

morning

U.S.

are

day.
of

the

closed.

and

Canadian

North

American

Europe.
which

the

the

Other

markets

the

morning

is their

a typical
in

of

about

macroeconomic

2009,

of

afternoon
Asia

ranging

American

announcements

from

and

3,

higher

index

indicator

are

index.

of

The

an

countries

released

while

coincides

announcements

March
often

session

macroeconomic

governments

ex-ante

Tuesday,

is

the

activity

employment

9.2

the

of

to industry-specific

as

consumers

potential,
value

Group.

serves

confident

economy

measure

Sachs

morning

Announcements

Most
includes
trading

for

Many

announcements

are

which

are

of

aggregates

financial

institutions.

major

media

various

forecasts

The

and

data

accompanied
made

consensus

every

week

consensus

by

figures

companies,

economists

by

forecasts,

economists
are

such

as

and

calculate

of

usually

various

produced

Bloomberg

LP,

by

that

average

poll

industry

expectations.
Macroeconomic
impact

news

on

arrives

from

currencies,

commodities,

derivative

instruments

is

technique

that

of securities

of Event

Event

trading

each

event

may

of

and

estimated

persistent

world.

The

fixed-income

using

impact

the

event

of news

and

studies,
on

the

prices

Arbitrage

be

to

many

different

asset

for

documented

classes,

every

yet

financial

persistent

the

impact

instrument.

impact

of events

of
This

on

various

in

foreign

instruments.

Foreign

Exchange

Market

responses

exchange

Markets
to

were

Edison
Love

the

is applicable

considers

financial

equities,

usually

measures

corner

of interest.

Application

section

every

studied

(1996);
and

macroeconomic
by

Andersen,

Payne

(2008),

foreign

exchange

that

news

about

real

economic

surprise

increases

by

documents

little

impact

of inflation

on

et al.

(2003)

conducted

their

quotes
intervals.
quickly
releases.

percent

interpolated
The
and

authors
efficiently

Volatility,

based
show
to
however,

on

such

At

new

takes

(1997);

(2003);

and

shows

that

time,

exchange
on

for

every
USD

the

author

rates.

foreign

to create

exact

exchange

rate

to taper

to
payroll

employment,

according

longer

significantly

nonfarm

same

analysis

average
levels

the

foreign

timestamps
that

as

payroll

average.

on

Vega

most

(1996)

nonfarm

appreciates

Andersen

0.2

reacts

Edison

in

and

Payne

others.

activity,

In particular,

and

Diebold,

many

finds

100,000

Goodhart,

among

(1996)

figures.

Almeida,

Bollerslev,

Edison

employment

announcements

to
off

exchange
five-minute
levels

the
after

adjust

information
the

spike

surrounding
that

most

bad

news

news

usually

et al.

(2003)

announcements.
has

The

more

authors

pronounced

also
effect

document
than

good

news.
Andersen
International
for

Money

estimation

authors
rate

of

then

R t as

use

the

Market

Services

surprise

model

the

consensus
(MMS)

component
five-minute

forecasts

of

as

news

changes

compiled
the

by

expected

the
value

announcements.

in spot

foreign

The
exchange

follows:

(4)
where

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is

surprise

the

periods,

component

and

is the

seasonalities.
following

value
of

the

time-varying

Andersen

et

of the
k th

fundamental

volatility

al.

(2003)

five-minute

that
estimate

variables:

GDP

(advance,

Nonfarm
Retail

preliminary,

and

payroll
sales

Industrial

production

Capacity

utilization

Personal

income

Consumer

credit

Personal
New

lagged

consumption

home

Durable

sales

goods

Construction
Factory

orders
spending

orders

Business

inventories

Government
Trade

expenditures

budget

deficit

balance

Producer

price

index

Consumer

price

index

Consumer

confidence

index

final

figures)

spot

rate,

variable
incorporates
the

impact

S k,t-j

lagged

intraday
of

the

Institute

for

Supply

Association

Management

of Purchasing

Housing

(ISM)

Managers

index

(formerly

[NAPM]

the

National

index)

starts

Index

of leading

Target

Fed

Initial

indicators

Funds

rate

unemployment

Money

supply

claims

(M1,

M2,

M3)

Employment
Manufacturing

orders

Manufacturing

output

Trade

balance

Current

account

CPI
Producer

prices

Wholesale

price

Import

prices

Money

stock

index

M3

Andersen,

Bollerslev,

following

currency

CHF/USD,

and

30,

1998.

positively,
following

EUR/USD
authors

with

99

index,

Managers

(NAPM)

responded

and

different
(2008)
the

percent

nonfarm

and

the

index.

(2008)

countries
studied

United

the

States,

3,
all

1992,

surprise

money
document

affects

different

impact

of

the

Eurozone,

the

that

the

industrial

balance,

currency

consumer
of

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pairs
in

considered
the

initial

M3.
macroeconomic

currency

pairs.

macroeconomic
and

in

employment,

increases

stock

responded

increases

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the

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pairs

surprise

the

DEM/USD,

through

currency

trade

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considered

USD/JPY,

to

orders,

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to
and

(2003)

payroll

goods

claims
Payne

that

significance,

negatively

unemployment

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document

durable

Vega

GBP/USD,
from

variables:

confidence

and

pairs:

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production,

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Diebold,

the

news
Love

news
United

from

and

Payne

originating

Kingdom

on

in
the

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authors

find

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in

the

respective

trading

domestic

equity

and

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news

by

are

the

and

also

the

originating

document
regions

in Table

the

on

their

9.3 .

Announcements

Payne

The
on

news

three

shown

News

effect

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(2008)

from

Region-Specific
Love

largest

affected

findings

per

day
and

to

to

firms,

two

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filled

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classical

with

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on

the

(2008)

macroeconomic

do

the

announcements,

macroeconomic

changes

The

likely

news

determined

by

riskiness

of

U.S.

equities

U.S.

Treasury;

the

is

discount

as
central

rate

of equities.

changes

sales,

impact

of

risk-free
share.

risk-free

by
rate

short-term

bank.

of equity

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earnings

is,

target

and

those

consumer

earnings

prospects
signal

and

the

risk-free
higher

tough
a result.

bare

minimum,

the

idiosyncratic

rate

pertinent

bill

interest

the

as

its

to

firms.

and

risk-free

significant

traded

conditions.

at

rate

are

in market

may

three-month

lower

publicly

expectations

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the

prices

with

however,

finance

proxied

of

uplifting

earnings

the

equity

confidence

costs,

equity

the

by

classical

level

often
the

retail

decrease

a particular

is taken

country's

in

associated

labor

and

rate

rates

affected

boost

in

earnings

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conditions

discount

country

to

outfits.

business

be

changes

expected

discount

increasing

are

retail

in

in the
may

example,

theory,

changes

earnings

spending

financial

factors:

and

prices

the

has

pairs.

markets?

According

that

news

of

their

of

exchange-rate

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both

for

type

Currency,

typical

due

Love

the

Effect

Respective

the

of

EUR/GBP

is most

Kingdom.

currencies;
9.3

Equity

U.S.

GBP/USD

impact

Table

the

while

United

specific

that

and

issued

equities
rate

in

the
the

the

another

announced

rate,
are

by

to

lower

theoretical

by
is

How

does

macroeconomic

empirical

evidence

interest

rate

other

shows

returns

with

90

percent

percent

announcement

prices

reaction

to

mixed.

Positive

inflation

independent

of

1983,

for

1985,

business

cycle.

are

news

during

periods

Roley

and
stock

rates

Cutler,

and

Poterba,

and

suggests

seconds

to

or

that

minutes

Several

for
of

the
high

stock

lower

(see

other

on

news

induce

conditions

conditional

of

the

activity,

returns

and

Roley,
variables

contemporary

during

usually

stock

macroeconomic

the

market

is

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state

industrial

economic

changes

of

production

recessions
according

rises,

response

but

only

but
to

the

figures
bad

news

McQueen

equities

Jagannathan
is

not
for

industrial

The

(2005).

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limited

to

production

have

and

following

U.S.

observe

the

figures

when

news

of

the

rising

asymmetric
when

actually
by

Boyd,

response

to

macroeconomic

Finnish

Lflund
response
equity

the

presents

confirmed

asymmetric
the

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During

hypothesis:

markets.

in

found

economy.

expansions.

in unemployment

asymmetric

were

increase

attributes

been

the

the

returns

overheating

increase

findings

instance,

drop

the

of

economic

(1992)

to

statistics

state
that

during

returns

is overheated,
news.

the

finds

Orphanides
of

economy

on

(1992)

contractions,

unemployment.

in unemployment

dependent

Orphanides

economic

in

tend

Higher-than-expected

unemployment

(1997),

to

monthly

evidence

within

manner,
long-term

macroeconomic

market

details).

reactions

example,

news

occur

to

long-term

(See

Anecdotal

shocks

other

unexpected

cause

good

for

strongly

(1993).

Similarly,
to

both
affect

rates.

nonmonetary

reactions

good

in

Ample

time.

Stock

produce

pronounced

confidence

example.)

of

a less

practice?

respond

positively

short-term

in

prices

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indeed

for

for

adjustments

in

statistical

confidence

Summers,1989,
most

news.
rates

equities

equity

and,

macroeconomic
interest

affect

that

announcements

short-term

99

news

and

Hu,

and

Nummelin
to

surprises

market;

they

found

that

sluggish

higher-than-expected
states

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the

or

of the

not

macroeconomic
are

volatility.

volatility

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is

not

macroeconomic
been
Kuttner
the

to

interest

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the

for

(2005)
Dow

higher

tells

announcements

are

announcements

to
price

figures,

or

interest

shows

that

during

periods

volatility.
that

Different
frequencies.

The
with

Karceski,

and
for

of

U.S.

if

higher

real

largest

information

increase

Lakonishok
and

and

Japanese

European
to

impact
in

(1998),

equities

risk,

and
by
equity

on

no

major

consider

news
of

employment
(1999)

example,

news

drives

asset

price

Hogan

(1998)

found

has

considerable

markets.

equities

equity
of

in an

news

Veronesi

stock

affect

frequency
for

U.S.

that

(PPI),

news

appear

to

macroeconomic

which

Errunza

macroeconomic

the

to

macroeconomic

of the

and

announcements

FOMC.

uncertainty,
markets,

are

the

sensitive

show

(2008)

index

more

are

Market

accompanied

when

price
of

in

comprising

higher

days

they

decisions

Open

response

be

Wilson

producer

and

macroeconomic

on

and

major

(CPI),

volatility

sources

than

Bernanke

Connolly

(2008)

U.S.

Savor

European
and

the

increase

be

rate

of

In the

on

made.

investors

monetary

impact

returns

index

higher

should

Wilson

major

have

component

implies

risk

and

news

of equities
in

market
other

volatility.

volatility

in

of

Federal

(DJIA)

higher

with

volatility

U.S.

prices,

stock

unexpected

volatility

Savor

are

announcements

consumer

that

that

volatility.

return

Average

us

days

the

in the

Higher

to

an

equity

spikes

Indeed,

on

in

increases

macroeconomic

that
of

increase

news.

returns.

stocks

stock

by

out

market

show

Industrial

theory

returns

in

increase

document

macroeconomic
financial

surprises

announcements

Jones

pointed

related

example,

(FOMC)

move

surrounded

(1989)

necessarily

rate

Committee

usually

Schwert

significantly

(2005),

bolsters

announcements

always

factors,

shown

growth

economy.

announcements

market

production

at

data

equity

appears
data.

analyzed

arbitrage

different

pricing

to
Chan,

monthly
theory

setting

and

equities

are

using
past

found
most

equities

of

the

Wasserfallen

equities

Flannery

and

and

announcements
to

be

in

rate,

the

and

decreased

and

the

al.
a

with

(1998,

poor

p.

job

in

frequencies.
news

sensitive

current

real

news

companies

from

PPI,

monetary

on

equity

returns

account

deficit,

domestic

the

model
following
on

aggregate,

both

balance

figures.
stock

a result,

for

markets

in

the

news

foreign
rates

and

example,

notes

that

in

response

AUD/USD
(GDP);

domestic

equity

exchange

increased

product

rising

return

macroeconomic

As

(1992),

of

generalized

influence

USD-based

Sadeghi

of

the

the

types

foreign

to

on

several

starts

that

the

returns

that

significant

States.

to

gross

following

by

have

housing

United

daily

(GARCH)

overreact

markets,
the

that

found

document

balances.

Australian

increases

et

estimate

and

typically

from

found

authors

CPI,

(1995)

account

the

individual

macroeconomic

heteroskedasticity

report,

countries

domestic

The

volatility:

Mehdian

tend

size,

most

return

impacted

announcements

employment

markets

of

of

do

monthly

impact

variables

macroeconomic

developed

Chan

By

that

(covary)

factors

(2002)

conditional

and

show
yield

tandem

individual

frequencies.

(1998)

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significantly

independent

Ajayi

low

dividend

in

at

no

news.

autoregressive

in

finds

are

returns

al.

macroeconomic

Protopapadakis

macroeconomic

of trade,

move

at

of

data.

equities

equity

et

and

covariation

(1989)

quarterly

with

that

the

return

Chan

equities.

that

returns

ratio,

corresponding

explaining

characteristics

future

portfolios,

factors

document

U.S.

of

book-to-market

are

returns

idiosyncratic

predictive

factor-mimicking
return,

182)

that

to

exchange
equity

inflation

returns

or

interest

rates.
Stocks
react
(1987),
exhibited

of

differently
for

example,
higher

to

different

industries

macroeconomic
pointed
sensitivity

have

been

announcements.

out

that
to

stocks

of

announcements

shown
Hardouvelis

financial

institutions
of

monetary

to

adjustments.
as

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well.

Li

extent

and

Hu

capitalization

are

are

stocks.

small-cap

The

size

of

impacts

the

surprise

average,

markets

than

did

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Jones,
employment
while

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of

and
the
the

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volatility

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decline

in

bonds

issued

move

the

prices

news

for

example,

standard

deviation

and

foreign

studied

the

of

exchange

and

incorporated

and

in

the

U.S.

Treasury
the

goods

impact

(2001).

orders,

nonfarm

on

the
the

information

employment

is

figures,

documents

higher

yields

market
those

in

that
bills

a
and

that

prices

just

two

of

curve.
10

GDP,
payrolls,

distinct

information

and

retail

sales,

and

is

fully

following

its

estimate

classes:

jobless
and

the
on

Remolona

announcement
starts,

and

(1993)

announcements

housing
PPI,

Lee

(1999)

Fleming

and

1999);

minutes

Remolona

macroeconomic

yield

and
new

to

Ederington

1998,

Ederington

show

responses
by

(1997,

(1998)

and

of

find

beyond

(1996)

bond

Remolona

Green

impact

authors

persist

that

include

and

Fleming

high-frequency

not

of

Treasury.

bond

announcement.

note

causes

of

Remolona

effect

markedly

announcement

Krueger

announcements

Elton,

The

increased
did

the

(1996)

prices.

U.S.

Fleming

bonds.

volatility

that

Edison

studies

(1993);

indicators,

bond

unemployment

the

macroeconomic

durable

than

prices.

bond

U.S.
by

Treasury

the

into
and

High-frequency

measure

one

(1998)

U.S.

indicating

(1987)

Balduzzi,

on

of the

promptly

and

entire

market

surprises

(1992),

in equities

Lumsdaine
data

day,

Hardouvelis

Fleming

large

macroeconomic

Schirm
within

changes

announcements,

incorporated

Lee

and

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matter

surprises.

and

announcement

PPI,

of

to

Markets

Lamont,

that

with

stocks

macroeconomic

those

larger

large

that

component

surprises,

caused

appears

to

Aggarwal

small

capitalization

show

sensitive

prices.

that

market

(1998)

more

the

equity

document

of

rate,
trade

the

(1999)
CPI,
leading
balance.

Fleming
be

the

and
actual

forecast
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of

Remolona
number

for

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and

authors

then

same

10

macroeconomic

document

the

to

variable.

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a

percent

average

to a 0.9

percent

statistical

the

2-year

average

percent

drop

released

from

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consensus

in the

impact

8:30

to

the

Table

yield

the

the

As

in

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bond

was

and

yields

in

drop

confidence.
30-year

in

in

macro

Table

9.4

rate

led

on

bill

with

95

yield

of

3-month

percent

news

a.m.,

jobless

of the

The

the

8:35

9.4 .

by

a.m.
of

change

in

a 1.3

8:30

changes

in

percent
of

at

surprise

and

99
yield

to

studied

the

average

increase

drop

with

of

curve

surprise

confidence

in

were

reproduced

percent

note

announcements

positive

are

surprise

Reuters

news

significant

results

Thomson

significance

yield

statistically

the

macroeconomic

release.

the

entire

the

less

(1999)

measure

response

shows,

news

Remolona

on

define

released

the

the

releases

(1999)

the

corresponding
not

statistically

significant.
Table

9.4

Documented

Futures
The

Effects
by

of

Fleming

Macroeconomic
and

News

Remolona

Announcements

(1999)

Markets
impact

market
Ederington

has

of
been
and

Becker,

Finnerty

(2004)

document

the

macroeconomic
studied

Lee

by

(1993);

and

Kopecky

that

news

announcements

Becker,
and

Finnerty,

Simpson

(1996)

and

announcements

and

on
and

the

futures

Kopecky

(1996);

Ramchander

Simpson

and
regarding

(2004).
Ramchander
the

PPI,

merchandise

trade,

bond

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futures.

adjustment

of

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the

volatility,

minute

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(2007)

whereas

effect.

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mature

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of
price

futures

happens

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15

minutes.

significantly
as

influenced

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to

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and

(GNPs),
exchange

Philippines,

stock

markets.

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the

rates

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money

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variables

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markets

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on
degree

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ASEAN

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supply

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lira/USD

domestic

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variables,

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to

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products

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markets

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of

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production

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of

equity

news

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estimated

affect

industrial

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size

on

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the

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Omran,

respond

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of macroeconomic

announcements

analysis

rate,

returns

relation

prices

news-induced

following

impact

that

announcements,

Kandir

local

the

example,

found

markets

affected.

the

move

released.

macroeconomic

authors

similar

exchange

how

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macroeconomic

national

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for

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domestic

equity

of the

CPI

exchange

news

persist

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find

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considered

study
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impact,

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(1993)

the

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were

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rate

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and

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bond

payrolls,

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on

nonfarm

and

countries,
their

that
interest

countries

stock

local

gross

rates,

and

(Indonesia,

significantly
(1990)

domestic

influence

found

no

causal

returns

of

Asian

Pacific

markets.

Commodity

Markets

Empirical

evidence

Gorton

and

activity

and

inflation

and

affect

inflation

prices,

except

on

Chambers

(1985),

and

relationship

between

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Investment

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real

traded

securities,

market

capitalization

1991
an

estate

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at

invested

in

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ratios,

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by

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estate,

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high

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monetary

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novel

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(2007).

the

prices

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in U.S.

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have
(1984),

details

fairly

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ordinary

changes

rates

have

dividends.

unexpectedly

(2007)

REIT

which

rates.

was

to

performance

increase

inflation

the

commodity

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Congress

2006.

the

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earnings

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real

rates,

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the

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effect

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and

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announcements
impact

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trusts

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rising

prices

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valuations.

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real

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announcements,

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volatility

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500

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in

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Fed).
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financial

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high-frequency

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directional

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on

events

make

markets

CHAPTER

10

Automated

Market

Most

MakingNave

high-frequency

automated
was

trading

(HFT)

market-making

entirely

mode.

human,

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successful

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systems

services.

but

chapter

are

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is now

moving

considers

the

market-making

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30

deployed

years

ago,

to a nearly
basic

fully

to

provide

this

activity

computerized

principles

behind

the

models.

Introduction
Every

veteran

market

trader

maker

instrument.

who

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profits

rare

lived

human

traders

market

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USD/CAD

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markets
bonus

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taking

bet

setting

fell

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properly
into

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futures

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at his
mark,

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efficient:

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computer
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participants.

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traders,

systems

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programming

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for
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development

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market

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markets

foreign

liquidity

to Order-Flow

Price

sensitivity

to block

large

market

market

induced

net

by

Kyle's

eat

the

lambda

after

idea

through

the

Price

sensitivity

trading

size.

Kyle

centralized

technical

techniques

limit

measures

main

directional
trade

without

order

books

and

how

the

market

price

low

liquidity

Imbalance

The

substantially.

the

the

analysis

strategies.

transactions

order.

order

price

between

an

technical

markets

because

provision

Sensitivity

following

that

unobservable

Price

moves

and

exchange,

reverse-engineer

profitable

speculate

The

is that

limit

order

book,

measures

volume

and

sensitivity

moving

the
the

makes

relationship

price

parameter

the

is

change
known

as

(1985):

(6)
where

P t is the

to the

market

sizes

recorded

Parameters

impact

specification
individual
is

the

(7)

and

of

price

the

Change

modified

less

bid

t are

then

(6):

to
the

liquidity

available

per

Volume

Kyle's

lambda

time

t is the

best

error

net
price
on

proposed

term

the

trading

by

time

with

regression,

The

each
and

measuring

directional

t .

regression

associated

imbalance.
large

at

linear

interest,

t due

between

quotes

of the

of

to

difference

of the

intercept

volume

t 1 to time

ask

components

parameter

changes

Unit

and

is the

the

from

NVOL

t is the

P t,

sensitive

price

and

best

lambda,

the

higher

follows:

the

of equation

Kyle's

lambda,

Price

of orders

at
,

in market

observation

sensitivity

the

change

lower

trades,

the
the
and

venue.

Aldridge

(2012d)

works

as

where

P t is a change

predefined

time

executed

at

the

best

during

best

during

by

market

a result

Technical

t:

Absolute

price

is

the

was

in force

at

trade

time.

as

the

sell

net

volume

while

buy

orders.

per

volume
each

volume

of

trades

The

difference
flow

was

matched

between

bid

trades

trades

trade

imbalance
at

the

during
of

time

order

orders,

observed

at the

executed

Resistance

change

trades

aggregate

S t a is the

the

and

executed

t , and

of market

Support

on

S tb

that

interpreted
period

generated
often

bid

prevailing

be

time

t,

period

ask

S t a can

are

period

at the

processed

in prices

is

S t b

observed
likely

to

processed

be

at

ask

Levels

unit

volume

traded

is yet

another

measure

of liquidity:
(8)
This

metric

ratio.

is

the

deeper

is

requires

average
the

(8)

and

accounts

volume

traded.

Market

Resilience

Market

resilience

how

quickly

order.
this

lambda,

available

equation

times,

Kyle's

price

of

of

(2002)

in price

attribution

metric

Amihud

to
change

smaller

the

the

order

per

the

another
book

market

that

unit

recovers

the

illiquidity

change

shape

is discussed

The

volume,
Kyle's

and

liquidity

estimates

instrument.

trading

of liquidity
its

resilience

of

bid

the

ratio

modified

absolute

metric

as

financial

prevailing

assumes

known

illiquidity

While

to

for

is

traded

change

trades

is yet

of

of

and

liquidity.

only

Estimation

ask
is

the
lambda

quotes,

the

balanced
in

and

at

price

per

unit

measures

following

all

just
market

in Chapter

15

of

book.

Profitable

Market

ensure

that

conditions

must

relate

arrival

and

to

Similarly

size-induced

To

due

the
prices

Making
the

market-making

hold.

of traded

The

rates

of

operation

conditions,
limit

instruments.

orders,

dating

is profitable,
back

probability

several

to Garman
of

gain

key

(1976),
and

loss,

Temporary

imbalances

differences

between

optimizes

his

budgets,

risk

appetite,

are

these

less

is to

latter

cash.

Both

which

may

access

to

than

buy

and

and

orders

due

way

host

order

other

imbalances

market

maker's

bankruptcy

maker

has

as

independent

arrive

in

problems

The

avoiding

dealer

of

optimization

create.

to

differences
a

aggregated

market

are

the

markets,

while

the

sell

and

underlying

help

profits

orders

reflect

the

differences

whenever

sell

trader

important

maximize

arise

and
trader

individual

optimization

objective

buy

individual

flow,

The

themselves

The

the

order

idiosyncrasies.

that

between

or

no

failure.

inventory

or

stochastic

processes.
The

model

solution

estimation

of

clip

million

of 10

when

and

a is

denoted

sell

securities

as

is

the
to

the

market

cash

when

the
the

at

(pays

money

a customer
the
the

or
the

bid

solution

to

a classical

maker
to

the
in

of

an

ask

price

departure

of

a customer

at

or

probability

of

the

comes

market

maker

in

dollar

market

probability

customer,

to the

Suppose

a security

lies

(e.g.,

securities

maker

buy

to

of

prices

arrives

customer).

maker

based

Gambler's

Gambler's
certain

Ruin
initial

all

known

his

as
the

certain
Under
will

buy

market

ask

price

P b,

order

to

can

be

b.

the

that

market
to

solution

loses

to

and

unit

exchange)
in

order

a . Correspondingly,

the

denoted
The

pays

bid

which

the

a customer

from

at

comes

dealer

clip

optimal

in foreign

departs

(the

arrival,

rates

customer

dealer)
to sell

the

for

lose

the

of wealth,
Gambler's

all his

money

In

the

a gambler,

position
This

unbounded
bets

the

Problem.

Problem,

money.

gambler
level

Ruin

wealth

an

on

and

wagers

version

of

problem.
until

he

at which
Ruin
is

or

either
point

Problem,

the
The
loses
he
the

dealer's

a dealer,
(stays

version
starts

out

in business)

Gambler's
bounded
all

problem

his

Ruin

of

the

with
until

Problem

problem
money

known

that

he
is

assumes
or reaches

exits.
probability

the

gambler

(9)

where

Initial

probability
Gain

is

losing

an

of

) is the

From

Wealth

the

probability

Gambler's

failure

is

certain

whenever

gaining.

In

the

other

( Loss

of gaining

an

It

can

) is

the

) of

initial

wealth,

and

Pr(

the

( Gain

can

see

losing

in the

exceeds

term

Ruin

following

two

if he

runs

out

of cash.

2. The

market

maker

fails

if he

runs

out

of inventory

satisfy

client

the

Loss

variables

other

words,

Gain

= 1

Loss

= 1

maker's
is

the

of

are

equity,

perspective,
probability
a of
one
The

Ruin

of

we

units

this

of

unit
unit

the

probability

selling

of

Gambler's

arriving.
inventory
Ruin

be

may

for

the

assume

the

may

the

a buyer
unit

Problem

inventory,

single

exchange,

gaining

arriving.

out

of

probability
of

Gambler's

running

foreign

for

of

positive

)> Pr( Loss

).

to

the

and

is unable

to

demand.

In modeling

of

is

ways:

fails

case

failure

Problem

maker

the

of

probability

is Pr( Gain

market

In

that

condition

long

probability

the

1. The

through

the

shown

Gambler's

in the

).

that

further

minimum

the

business

Pr( Loss

be
of

the

applies

cash,

we

probability

failure

start-up

amount

Problem,

words,

(1976)

market-making

amount

positive.

of avoiding

Garman

gambler's

Ruin

always

probability

the

be

unit

that

a share
a clip.

inventory,

is

Problem

the
b,

equation

and
logic,
probability
(9)

now

of
it

and

asset.

the

the

unit

ruin

Gain

In

from

one

same
the

stock.

Then,

of

the

financial

of

losing

maker's

both

underlying

of

By

market

In

case
market

inventory

equals

the

the

probability
of

seller

becomes

(10)

where

E 0 ( P a , P b ) is the

initial

average

price

of an

underlying

unit

of

inventory

and
is

the

initial

number

of

units

of

the

financial

instrument

applied

to the

in

possession
of the
The

market

maker.

Gambler's

Ruin

probability

of

maker's

failure

due

perspective,

when

a buyer

willing
the

Problem

to

market

market

at

maker's

seller

of

the

Gambler's

of

arrives.

probability

security
Problem

now

the

the

market

dollarhappens

the

arrival

of a buyer

a . As

a dollar

is P a . Similarly,

giving

security

takes

From

maker's

probability

or

the

market

before,

with

losing

selling

cash.

cashsay

of gaining
of

for

of

As

P a happens

probability

Ruin

out

a unit

security

price

maker's

running

gaining

of the

buy

to

is further

away

at

price

following

result,

dollar

P b is

the
to

b.

The

shape:

(11)

For

market

equations

(10)

words,

the

maker
and

to
(11)

remain
need

following

in

business,

to be

the

satisfied

two

first

conditions

simultaneously.

inequalities

In

have

of
other

to

hold

contemporaneously:
b >

a and

a pa >
For

both

true

at

spread

apb
inequalities
all

times:

allows

sufficient
true:

the

market

to hold

same

p a > p b , defining
the

market

inventory
existence
maker

at the

of the

satisfies

the

maker

positions.

The

bid-ask

profitability

time,

to

the

bid-ask
earn

reverse,
spread

following

spread.

cash

conditions

not

The

while

however,
does

must

be

bid-ask

maintaining
does

not

guarantee

of equation

that

hold
the

(11).

Summary
Market
and

making
deserves

feasible

with

and

any

compensation.
very

simple

liquidity

provision
Profitable

models

that

is a service
automated

only

take

to the
market

into

account

markets
making
inventory

is

on

the

market

maker's

therefore,

desirable,

extracted

out

of

books.
the

Level

While

information
I data

Level

II data

delivered

using

simple

by

is informative,
Level

techniques

II data
like

and,
can
technical

analysis.
End-of-Chapter
1.

What

Questions
is

market

making?

How

does

it

differ

from

liquidity

the

common

provision?
2. Why
3.

What

is market
is the

making
core

inherently

market-making

profitable?
strategy?

What

are

extensions?
4. What
5.

What

strategies?

are
are

the
the

common
minimum

measures
profitability

of liquidity?
conditions

of

market-making

be

CHAPTER

11

Automated

Market

Making

Inventory

market-making

and

manage

help

imbalances
with

immediate

spot

to

models

do

contrast,

this

chapter

demand

in

in

Chapter

prices

or

portfolio.

The

an

inventory

level

and

consider

proceed

and

actions

10,

resulting

adjust

start

to

the

satisfy

inventory

conditions.

information

the

usually

sufficient

market's

explain
from

models

to

the
and

information-based
carefully

Such

available

in

expected

future

as

What's

the

well

This

to

other

market

and

time,

and

between

the

show

timing

cases

The

some

may

Case

1: Market

optimize

supply

and

present

and

order

book,

order

outcomes.

that

manage
cases

for

sample

book

apply

to

for

horizontal

its

market
to

all

matching

axis

is time.

The
observed

dashed

line

shows

the

midquote:

trades:

occur

in the
Does

some

best
trades

vicinity
Not

Move

ask.

The

occur

of either

I data

figures

observable
from

venues

solid

offer,

the

The

that

given

deploy

operation.

best

and

detect

accordingly.

situations

Level

trading

to

positions

illustration.

a.k.a.

bid

is sufficient

one's

ask,

best
of

of limit

trading

subscribing

cases

order

best

the

shape

for

in

market

and

available

account

and

and
four

the

the

of various
them,

to

information

presents

limit

the

to

the

carries

participants

figures,

available

of orders

movements

venue.

all

patterns

models

including

data

price

centralized

trading

addressed

Data?

accompanying

trading

models

responding
The

histories

section

all

news
by

trading,

available

short-term

the

markets.

as

in the

Publicly

the

process

demand

flow,

market-making

evaluate

deduce

market-making

and

book,

demand,

not

participants,

bid

variations

inventory,

client

discussed

participants.

By

In

transitory

client

according

by

models,

in a dealer's

a sweet

market

II

at
bid

lines
at the
the

are
given

simple

stars

indicate

ask,

some

or ask.

the
point

in

average
the

at

best

bid,

price
and

In

Figure

the

first

finally

at

11.1

, the

trade

moved.

the

best

11.1

bid

is the

The

recorded

in

the

best

then

at

best

bid

again.

dynamic

11.1
that

arrived

trade

was

recorded

market

sell

time

move.

to

question

The

bid,

Neither

the

at

in the

work

the

following
the

sequence:

best

nor

market

ask,

and

best

ask

the

shown

at

order

about

the

first

are

executed

market

sell

order.

bid

side

of

and,

sell

in size

carry

best

any
the

in

Figure

their

risk.

buy

therefore,

orders

than

the

size

the

trade,

bid

order
must

the

market

is

be

likely

shows

that

The
a

trader

11.1

orders

sell.

would

next

trade

Once

bid

buy
such
be

two

not

from

the

quotes
been
or

the

revised

additional

order

and

because

it

matched

with

is recorded
again,

at

did

ask

the
have

as

not

The

participants

would

market

bid

best

they

identified

buy
book.

of

be.

best

best
least

first

sellthe

at the

at

in

The

would

the

and

shown

a market

sell

afterward:
order

market

happening.

was

other

Figure

askmarket
limit

is

knowledge

market,

to Trades

the

information,

Had

the

order,

In

trade

best

levels.

shortly
The

of the

bid,

specialized

to minimize

orders

ask

market

not

movement

at the

unusual

arrivedfollowing

their

the

or

as

original

Following

none.

the

at

quotes

is

the

smaller

did

in Response

in

perspective:

imminent

Move

resulted

market

concerned

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interesting

was

order

remained

recorded

this

and

order

the

broader

their

Does

, nothing

order

the

Market

answer

Figure

best

at

are

short

the

trades

occurred

What

Figure

11.1

Figure

is

at the
11.1

shows

no

The

size

sizes

changes
of

both

at the

The

in prices
orders

best

orders

following

bid

were

was

and

not

either

small

the

best

perceived

order,

implying

in

comparison

have

any

that

with

aggregate

ask.
to

special

informational

advantages.
Case

2: Market

Figure
bid.

11.2

Moves

presents

Following

over

and

Rebounds

a different

the

bid,

the

scenario:

quotes

drop

a trade
lower,

is recorded

yet

at

gradually

the

recovers

time.

Figure

11.2

The

Market

Moves

and

Shortly

Rebounds

Following

Trade

The

trade

in

Figure

triggered

by

that

followed

1.

was
The

bid;

a market

trade

the

11.2
sell

by

size

occurred
order.

gradual

was

at
The

the

relative

market

sell

order

had

Despite

its

large

size,

the

drive

the

and

subsequent

recovery

large

bid,

drop

suggests
to

the

to sweep

was,

therefore,

in the

quotes

that:

size

available

through

the

at

book

the

best

to be

fully

matched.
2.
that
levels;

the

In Figure
may

due

inventory
quote,

trade
11.2

be

just
a

pricethe
carried

, the
to

best

the

market

quotes
no

maker

via

did

not

slowly

move

the

recovered

fundamentals

to

their

original

information.

ask

market

acquired

trade

quote
makers'
the

can

sell

also

drops

activity
trade.

promptly

following
seeking

By
sell

the
to

lowering
the

newly

sell.

This

disgorge

the

the

ask

best

purchased

inventory,
Case
The

realizing

3: A Trade
trade

above,

in

the

Figure

sell.

containing
Case

levels,

but

price

level

the

in

placed

came

in at the

bid

the

sell,

warrant

ask

quotes

their

Figure
and

not
new

recover
lows.

as

is

hence
a

trade

price

decline.

their

original

to

The

of fundamental

11.3
was

however,

a permanent

did

result

ahead

of
may

to

protect

counterparty.
to

as

market

participants
traders

determine

ways.

sell

referred

informed

again

at

may

superior

broker-dealer

losing

Figure

is observed.

in

quotes

the

several
the

possesses

executed

and

activity

remained

makers

information

orders

in

new

persistent

information

carried

trade.

market

who

bid

market

to

the

likely

both

Case

trade,

of

information

instead

Unlike

the

of quotes

interpreted

above,

bid.

Markets

once

markets

is most

sell

Moves

the

following

recovery

trade

at

shifted

explanation

enough

Unlike

occurred

recovered

immediate

The
The

also

substantially

likely

information.

Markets

quotes

A Trade

most

profit.

11.3

the

No

11.3

The

The

Figure

trade

downward.

by

Moves

where

11.3

a quick

Often,

market

be

the
himself
Such

prehedging.
may
through

the

order

research
other

that

first

to

against
activity

the

the
the

information-extracting

the

trader

the

trader

places

quotes

perfectly

Alternatively,
determine

that

situations,

accepting
is

possessed
of

routinely

such

adjust

trade

observe

and
In

sell

broker-dealer

may

skills

traders.

the

profitable
the

after

further

trader's

the

trade

trades

legal,
broker-dealer

probabilistic
models

and

is

with

is

often

and

other

presence
described

of

later

in this

chapter.

Case

4: The

Quotes

Figure

11.4

illustrates

widen

following

Figure

11.4

The

can

The

be

to

the

time

the

news,

closest

shown

in Figure

Cases

following
Market

described

where

spreads

Information

following

have

been

the
take

autocorrelation

Order

flow

aggressiveness
order

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11.5

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as

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flaw:

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technology.

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increased

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spoofing

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markets:

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accounts.

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States

prosecuted.

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of

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trading

in the

considered

cause

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for

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illegal

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price

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all

limit

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example,

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across

peaks

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the

orders

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of

illicit

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as

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activity

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are

section.

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high

is a truly

or low

frequencies.

portrayed

in

pumped

or

to dump
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it at the

investors.

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instrument,

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opportunity,

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thought

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at

and
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size

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expense

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(2010)

seller-initiated

of

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and
impact

trades,

for

at

or down

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and

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function

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example,

raid,

financial

first

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of

securities,

capitalize

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necessary

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and

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conditions

for

opportunities:
should

trades.

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of

dust.

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a profit

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market

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permanent

the

well

brokers

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reverse

of

where

depresses

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momentum
(2004)

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whether

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differ

12.1

value

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that

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of

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of

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at time

t, where

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size

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of

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markets

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examine

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impact

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order

Figure

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by

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12.2

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market

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of

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windows,

a number

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ticks

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of trade

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of Events

over

f,

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length

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after

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in Market

function

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obtain

the

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specification:

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evaluate

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specification

for

, consistent

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Glantz

(2002);

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feasibility
the

market

Breen,
and

and

of

pump

and

as

a function

and

Korajczyk

impact
Hodrick,

Lillo,

Stanzl

the

Farmer,

(2004)

and

and

dump,

we

of trading

linear

volume,

(2002);

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Gatheral

use

Kissell

(2003),

V
and

following

(2010):

(5)
where

V t is

the

size

sizedependent
impact

of

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hypothesis,
financial

is

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t,

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be

time

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at

estimated

instrument,

at

will

trades.
trading

be

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activity

null
of

follows:

(6)
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the

specified

alternative

hypothesis

ruling

out

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and

dump

can

be

as:

(7)
The

framework

manipulative

above
activity

allows
in various

for

straightforward

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instruments.

screening

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coefficients
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indicate

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interesting

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fund

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no

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bid-ask

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statistical
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as

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intercept,

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stock-specific
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volume-dependent

component,

(2003);

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versa.

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equities.

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value

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of

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of

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(2005)

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dependent

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on

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of

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Learning

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learning

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machines

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and

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with

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learning

theory
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a

type
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unsupervised

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analysis

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uncover

threatening

data

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minimize

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regression

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to

patterns
intelligence,

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data

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learning

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seeks
any

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identify

relationships.

unsupervised
signals

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learning

networks

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each

supervised

learning

under

categories:

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the

fit

data,

information

identification

two

relationships,

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unstructured
to distill

into
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of

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by

learning
observing

points.

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variable

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so-called

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can

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learning

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previous

data

learning

supervised
is

machine

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intelligence.

analysis

learning

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participants

in control

or

example,

should

and

technology.

Independent

machine

basic

investors.

event

for

investors

market

machine

regression,

a result,

more

Machine

linear

Kass,

Terminator

of

Each

worrisome

reasoning

originates

analyses.

most

that

attack

traditional

learning

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Doug

independent

of such

estimators.

nature

in data.

of

of

proposed

fundamentals

machine

series

one

commentator,

HFT

some

exposure

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as

unexplained.

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among

cited

impact

machines

capable

Arnold

resonates

cited

A CNBC

conversation

down

market

algorithm,
Y , for

instrument,

for

instance,
is fitted

example,
a

time
with

works
series

a function

as
of

follows:

returns
G ,

a
on

expressing

dependence

of

parameters

Y on

returns

of

another

financial

instrument,

X ,

and

(8)
Next,

the

boosting

error

term

is computed

as

follows:

(9)
where
,

I st<>0

is the

) matches

series

indicator

Y t precisely,

w t represents

time,

with

later

function

all

and

1 when

boosting

weights

in

iterations

recomputed

machine

learning

taking

weights

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first

on

value

of 0 when

t is not

equal

to

assigned

iteration

according

to

set

to the

to

0.

each
1,

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time

observation

and

following

G(X t

weights

in

calculation:

(10)
where
(11)

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G(X t ,

) that

learning

and

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testing,

devoid
may

term.

and

dependent

trading

the

variables.
was

application

and

function

researchers

running

the

machine

such

suffer

from

underpinnings
in the

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capable
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of

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for

stable

in the
as

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long

spurious

behavior

written,

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data

relationships

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was

intelligence
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for

book

certainly

sizes

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are

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time

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reliable

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relationships

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predictors,

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learning

select

economic

been

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Y t . Human

algorithms

of

have

fits

additional

learning

mining
that

closely

simulation

training

methodology

no
its

of

machine
immediate

to humans.

Summary
This

chapter

adverse
fears

discusses

outcomes
surrounding

however,

HFT

are

manipulation,
reducing

from

a
yet

the

risks

direct
even

algorithms
HFT.

As

strategies

often
the

chapter

are

unwarranted.

consequence
those

to all market

presented

strategies
participants.

of
can

as

illustrates
Some

evidence
most

screened

of

the

strategies,

high-frequency
be

of

market
for,

greatly

End-of-Chapter
1. What

Questions

is latency

2. Suppose
NYSE
or

at 125.07

negative

impact

of IBM

is simultaneously

in Tokyo.
on

the

Does

price

latency

of

IBM

trading

at 125.03

arbitrage

deliver

from

the

market

on

positive
efficiency

is spread

What

kind

of

scalping?

What

layering

is

is rebate

manipulative?

capture?
What

kind

of

layering

benign?
5.

the

of view?

3. What
4.

a stock

and

point

arbitrage?

How

can

one

detect

manipulation?
6. What

is machine

learning?

pump-and-dump

high-frequency

is

CHAPTER

13

Regulation
At

the

time

already

this

Indeed,

other
as

traditional

of HFT

machines,
May

6,

ATS

BATS

and

the

Group

imminent

directions.

call

public

Trading

This

traditional

for

stricter

of Regulators
issues

the

of

discusses

such.

flash
of

March

loss

current

as

(IPO)
on

of

monitoring

as

offering

same

automation

regulated

System)

chapter
and

than

such

the

the

instrument.

be

failures

was

at

much

financial

more

$10-million-per-minute

HFT,

main

little

(HFT)

tracked

follows

given

should

initial

1, 2012.

to

is

of market

Alternative

August

however,

spectacular

Currently,

HFT

botched

activity,

in

regulation,

the

Initiatives

trading

and

2010;

trading

of HFT

processes

examples

relevant

Key

market

shows,

citing

(Best

on

high-frequency

regulation

of

book

trading

Proponents

of

Current

forms

this

written,

regulated

level.

as

was

heavily

broker-dealer
rules

book

crash

electronic
23,

Knight

modern

of

2012;
Capital

legislation

approaches,

and

likely

Worldwide

on

the

regulatory

table

include:

Jurisdiction
Stability

of systems

Investor

protection

Efficient

trade

Market

structure

This

section

matching

considers

each

of the

issues

in detail.

Jurisdiction
The

long

shadow

cast

their

mandate

and

objectives

due

to philosophies

Most

of

regulators
certain

to

by

provide

of market

U.S.

regulation

prescribe
behaviors

and

market
legal

regulators
oversight

regulators
histories

have

observed

to

evolved

in the

markets.

as

as

at
on

part

large.

of

Roles

a regional

basis

jurisdictions.

a rule-based

remedies

HFT

markets

of individual

represents
specific

covers

well
By

approach,
as

in

punishments

contrast,

regulators

which
for
of

the

European

system,

Union

whereby

conformance
The

with

to

systems

in

the

been

markets

for

alike.

Behaviors

grain

of

the

tenet

action

that

of

of

integrity.

The

approach

to

to

dealt

are

the

be

objective
equal

widows

European
to

to a contingent

orphans
against

actively

Union,

of

access

and
to go

are

be

regulatory

the

considered

distilled

can

between

allowing

for

its

systems.

models

States,

behaviors

In

can

developed

U.K.

the

identified,
however,

fairness

of

of traders

regulation,

the

gainsan

may

international

run

and

Exchange

Commission

afoul

Swaps

and

under

the

itself

is not

within

jurisdiction
regulated

of

to

be

future

market

developments

regulators

financial

key

forward-looking

seek

regulation,

International

by

country,

rules

several

(SEC)

like

futures

of

Canadian

the

each

regulatory

Commodity
contracts

more

The

to

and,

Organization

of

(IOSCO).

adopted

products,

by

styles.

tends

anticipate

standards

arise

developed

example,

impact.

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capital,

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suppliers

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all
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End-of-Chapter
1.

What

are

Questions
the

key

types

of

risk

faced

by

a high-frequency

trading

operation?
2. How
3.

to measure

What

is

trading
4.

the

and
credit

mitigate
and

market

risk?

counterparty

risk

from

high-frequency

perspective?

What

are

the

key

problems

in

high-frequency

portfolio

optimization?
5. What
1 The

is liquidity
hat

parameters
to comprising

risk?

notation
were
the

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on
estimated

true

to measure

variables,
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distribution

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it?
in

a sample
values.

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, denotes

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as

that

the

opposed

CHAPTER

15

Minimizing

Market

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execution,

routing,

refers

used
An

to

order

and

transmit

at

certain

the

highs

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algorithm

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human

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portfolio
natural
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detail

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savings

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commission

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by

best

execution

human-driven
for

market
clients.

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chosen

algorithms

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the

trader's

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benchmark.

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pinpoint

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execution

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execution

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to

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algorithms
algos

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traders

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investors,
large

positions

as

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to

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Figure

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be

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trading

footprint

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the

footprint

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minimized?
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execution

orders

can

maximize
investors
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process
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Figure

executed

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fewest
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however,

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with

helps

may

their

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the

are
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limit

polling
proper
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current

market

rapidly

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most

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exchanges

for

their

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executed
limit

orders
multiple

with

the

most

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best
Figure

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for

a given
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for

liquid

markets.

available
most

liquidity
in

executed
15.2
their

order

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orders,

rapidly

exchanges

exchange

conditions.

the
on

therefore,
liquidity,

and

first.

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least
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illustrates
liquidity
or order

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liquid
markets

a sample
levels
slice.

and

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the

example

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(shares,

liquidity

500

units

market

ensures
the

or

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on

equal

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trader

place

2,000

aggregate

exchange

size
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of

would
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or

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next

with

units

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limit

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or

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place

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buy
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the

exchange:

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buy

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against

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trader

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units.

trade

order

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liquidity

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available

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units

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order

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bid);

footprint,

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exchanges:

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to

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3 has

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to

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trader

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3 and

his
go

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book

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and

there.

market

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trader

example,

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would

the

15.2

bid-side

minimize

leaving

order

liquidity

the

exhausting

market
our

fewer

that

Figure

units;

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orders

market,

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and

of 3,000

sell

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in

available

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3,000

than

has

contracts,

has

for

shown

the

the

lowest

bid.

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limit

first

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1,
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the

orders

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may

at

or

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may

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underlying

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orders

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to

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order

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2,

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place

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market

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probability

impact

trader

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exchange

fewest,

highest

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buy

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orders

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maximizing

minimize

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markets

are

discussed

trading

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explained

as

the

trader's

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every

order

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or

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execution.

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algorithm.

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at different

exchanges

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an

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information

as
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content

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placing

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situations,

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disturbance

capital.

information

in

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trade

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committed

necessarily

and

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every

sizes

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5. The

beliefs

action
of

speed,

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order.

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in Chapter

be

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as

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exchange

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limit

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place

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proceed

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orders

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ability

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fund

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to

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and

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a

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cost

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to

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fund's

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of

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first

order

do

market
so,

exhaust

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and
trader
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polling

ask

for

orders

the

best

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beginning

trader

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placing

the

beginning
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with

all

smaller
with

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than
the

the

rotating

bid-liquidity.

the

ask

liquidity

at

market

buy

at

each

bid-side
all

among
Figure

sequentially

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the

orders

by

placing

one.

increase

buy
and

best

liquid

and

liquid

markets

and

most

orders

increasing

accessible

available,

top-of-the-book

the
of

on

size

to limit

best

direction

ask
or

exchange,
may

liquidity

liquidity

the
the

15.3

the
by

exchanges,
exchanges

illustrates

in
such

strategy.
Figure

15.3

Maximizing

Trading

Size

Implementation

of

Execution

Algorithms

Most

researchers

develop

execution

algorithms

in

the

following

sequence:
1.

Researchers

research

in

explore
the

implementation.
research,

arbitraged

in the

algorithm

of

Some

available

the

area

may

published
optimal

traders
fearing

markets.
result

and

execution
may

that
In

in an

not-yet-published

reality,
algo

be
all

skeptical
known

a change
with

algorithm

an

of

academic
design
using

research

and
publicly

has

been

in parameterization
entirely

different,

of
yet

still

valuable,
2.

output.

The

such

researchers

as

MatLab

programming
3. The

algorithm

predictions

own

orders.
If

the

and

or

and

FAST,

and

Slicing

large

orders

(1995),

for

example,

the

the

all

trading

expensive

and

are

then

to

execution

can

enabled

shows

the

to

to

faster

by

assumptions
the

algorithms,

execution

algorithm

communicate

in

such

at

once,

difficult,

Gatheral,
be

. The

broken
first

making

as

slice

of

typical

account

schedule

is

moved

real

time

FIX,

ITCH,

at a time
Schied,

down

answer

the

following

questions:

Figure

15.4

Layers

of Algorithmic
and

for

and
into

three

called

the

Slynko

about

into
using
OUCH,

Slynko
distinct
macro

(2012)

Lakonishok
trade

60

smaller

a certain

Execution

and

execution
The

over

Chan

institutional

simultaneous
impossible.

layer,

Schied

if

it would

if not

one

research

that

15.4

Gatheral,

utilizing

satisfactory

languages

Figure

Source:

data

generated

outcome,

code

Java.

tick

is imperative:

volume,

executed

According

in

languages

their

or optimized

historical

-sending

econometric

transition

movement

risk
is

in

like.

executed
daily

C++

results

and
it

algorithm
a result,

on

price

step

where

quote-receiving

were

like

about

cost,

production,

as

is tested

previous

price,

the

R and,

languages

and

4.

model

percent
of the

child
time

trader,

of
order

orders

period.

(2012),
layers,

size

algorithmic
as

shown

allows

us

in
to

How

to slice

order

slicing

When

the

algo

should

be

day
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what

order

order:

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is the

general

rule

behind

the

algo's

at what

time

of the

should

each

child

mechanism?

size

should
algo
the

trade:

initiate
algo

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its

frequently

child

and

trades?

should

trade:

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should

trade:

large

be?

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how

algo?
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the

long

the

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does

second

defines

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layer,

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as

can

properties

or

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for

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is

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horizon

of

the

stop?

which

additional

micro

algo

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for

market

described

each

child

deciding

order,

as

the

order.

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whether

and,

for

decides

to

to

limit

micro

trader,

particular,

execute

orders,

the

the

what

child

price

to

set.
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the

child

orders.

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the

smart

past

developing

two

macro

all

tailored

strategy

groups.

trading:

it

average

price

is

can

(VWAP)

execution.

As

At

is

such,

conditions.

outperform

solutions

on

first
static

market
static

is an

example

determined

given

delta

strategies,

strategies

since
and

perform

is an

dynamic

static
well,

strategies
but

only

router

and

can

dynamic
ahead

of

volume-weighted

strategy.
during

example
may

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the

on

course

of a

strategies
do

of

contemporary

seem

under

in

conditions.

static

depend

the

decisions

order

refined

hedge

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determined

of a static

strategies

send

made

market

into

conditions.

dynamic

conditions

the

and

to

been

smart

is completely

market

glance,

has

the

classified

past

dynamic

strategies

be

venues

execution.

and
to

strategy

A simple

best

trader,

precision

which

progress
for

great

based

strategy

strategy.

micro

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a dynamic

certain

significant
solutions

the

with

execution

current

years,

trader,

Optimal

market

router

mathematical

of the
be

order

dynamic

to

always

respond
not.

In

to

reality,

specific

market

assumptions.
The

performance

of

both

static

and

dynamic

strategies

is

often

compared

using

benchmarks,

for

example,

the

following

simple

prices

per

traded

metrics:
Average

realized

received

under

price

compares

different

the

actual

unit

algos:

(2)
where

P j is the

size

of child

order

Pretrade
order

realized

P 0

price

temporary

is the

total

size

V =

trading

trading

time-weighted
VWAP,

be

Table

discussed
Kissell

grouped

category

Pretrade

V j is

the

time

the

other

Table

Order
Intratrade

15.1

benchmarks
Execution
Posttrade

this

known
Benchmarks

such

others.
V Daily

is

the
of

liquidity.
performance
algos,
of

order

execution

of

such

volume

various
of this

pretrade,
classification.

ahead

In

to

comparison

sections

categories:

summarizes

allows

percentage

(2005),

broad

than

at t

used

liquidity.

evaluating

and

P recorded

execution

(TWAP),

P t

P t on

algorithms

of available
for

regress

, where

day,

the
have

of

price

of

V/V Daily

common

Glantz

three

the

better

shortfall,

and

(2005)

dependency

perform
size

after

stream,

to available

in subsequent

into

includes
15.1

the

security

et al.

particular

implementations

to

posttrade.

relative

advantage

price

trading

when

benchmarks

include

by

comparison

trade
a

the

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may

to take

average

benchmarks,

can

V j allows

on

common
algos

According

j , and

at

of

, Almgren

significant.

volumes

volume

addition,

MI,

order

prevailing

price

t post

algorithms

ability

execution

child

induced

time

volume-adjusted

algorithms'
In

the

some

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or

price

the

P j,post

statistically

large

conditions,

is

identify

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trade

process

market

effects,

pinpoint

to be

Total

the

P j,post

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t , and

post

is

liquidity

disappeared.

ceases

slice

placed.

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on

for

j.

price
j was

price

of execution,

as

(POV),

intraday

price

chapter.
benchmarks
intratrade,
The

and

pretrade
such

as:

Decision

price

Previous

close

Opening

price

Arrival

VWAP
TWAP
OHLC

Kissel

Trading

and

Glantz

decision
decided

Previous

day's

close

working

with

traders
Daily

open

the

was

price

at

which

advantageous
price,

for

which

can

the

trader

or

portfolio

trading.

be

used

as

a benchmark

for

daily.

price.

Arrival

price,

broker

received

the

intratrade

price

the

determined

TWAP,

also

that

was

includes

the

using

on

of daily

posttrade

when

open,

category

following

intraday

determined

average

prevalent

the

executing

order.

category

VWAP,

The

(2005)

price,

manager

The

close

price

Source:

The

Future

prices.

the

basis

high,

of prices

low,

includes

benchmarks:

the

and

future

throughout

close

prices

close,

the

the

day.

(OHLC)
price

not

known

a large

order

in advance.
TWAP
TWAP
into

attempts
equally

time

is

sized

intervals.

the

order
the

to

conceal

parcels,

the

order

which

are

Mathematically,

every

then

TWAP

predetermined

arithmetic

flow

average

of

by

breaking

sent

out

executes

at equally

a fixed

unit

of time.

The

prices

sampled

at

portion

resulting
the

spaced
1/ T of

TWAP

price

regular

unit

time

. When

trader

the

trader

intervals:
(3)
The

TWAP

chooses
also
to

algorithm

to

needs

size
order

S/N
of

execute
to

execute,
is
size

is

a large

decide

and

the

sent

to

S is

illustrated

on

the

order

the

total

in
of

total

processed.

size

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N of

time

every
total

15.5

S using

number

execution
market

Figure

TWAP,

child

T . Next,

T/N

an

seconds,

number

orders

of

or

order
until

slices

slices

slice
the

and

of

entire
the

execution
the

time

traded

T are

security.

variation

in

beginning

volume
of

child

does

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not

enough

so

reasonable

represented

as

in

to

Figure

of

large

include

market
other

depth

the

market,

yet

can

each

be

the
The

that

each

large

executed

order

child

at

variables.
so

order

to

historical

enough

TWAP

, with

specific

small

move

resulting

15.6

day,

slices

entire

The

may

host

select

the

T.

characteristics

trading

significantly

that

time

the
and

is

using

characteristics

execution,

objective

order

determined

throughout

overarching

frequent

best

flow

order

or

within
can

drawn

be

as

an

arrow.
Figure

15.5

TWAP

Process

VWAP
The

VWAP

algorithm

methodologies.
large

order

the

trading

trading
larger

in

such

pool

determine

principle
a way

volume

volume

cost-effective
To

The

is currently

is
of

is

matching

of

of VWAP
that

higher,

lower.

one

Higher
orders

most

popular

execution

is straightforward:

VWAP
and

the

child
child

trading
and

break

orders

orders

are

volume
result

are

is
in

larger
smaller

likely
faster

to
and

up

when
when
provide
more

execution.
the

execution

schedule,

the

VWAP

algorithm

uses

map
one

of historical
shown

using

for

volume

hand,

the

every

trading

scaled

by

during

that

sizes

of trading

data:

for

the

of

the

the

time

Figure

15.7

Map

VWAP

past

day,

are

the

as

day,
of

With

in

often

map
the

determined
the

such

total

order

historically

equation

(3).

algorithm.
of Resulting

of Historical
and

Chriss

Process

TWAP

Volume
(2000)

Order

Averages

Flow

for

(or

Futures

the

other

shows

VWAP
as

as

computed

15-minute

VWAP

volume

shown

is

every

month.

orders

proportion

variations,
map

the

trading

child

period,

VWAP

Almgren

trading

throughout

VWAP

Diagram

15.8

. The

over

15.6

Figure

15.7

the

Figure

Source:

Figure

of

period

the

volume

in

month

interval

average

of intraday

equities

preceding

duration)

diagrams

averages

the
map

follows:
size

in
for

is

observed
Figure

15.8

(4)

The

resulting

benchmark

VWAP

price

can

be

determined

as

follows:

(5)
The

VWAP

map

accurately

reflect

average,
that
VWAP

is

utilizes

specific

markets

change

little

data

trading

hourly
April

volumes

in

2010,

the

uptick

in

their
month

2009
the

and

the

VWAP

volume

at

the

open

of activity

at the

Figure

15.9

futures

(FGBL)

by
market

Persistence
POV

April

a lull

of

the

Such

of

2010.

volume

have

the

remained

largely

the

European

and

lunchtime,

of

variations

that

Figure

15.9

computed

average

grown

map

orders

patterns:

futures,

While

on

success

example,

Eurobund

not

so,

child

relative

volume
For

does

Even

intraday

next.

futures

postU.S.

and

allocation

intraday

for

Eurobund

of

followed

the

map

shape

sessions,

own
to

VWAP

an

liquidity.
of

data

conditions.

deliver

persistence

one

historical

market

intraday

possess

for

on

can

the

on

from

the

solely

algorithm

based

illustrates

based
concurrent

a VWAP

efficiently

using

is

hourly

from
the

2009

to

same:

the

U.S.

followed

by

an

trading
a

spike

close.
of

Intraday

Volume

Distribution,

Eurobund

According

to

(CFTC)
the

the

and

causes

the

the

first

to

started
of

over

the

Figure
and

$4.1

previous
15.10

the

determined

for
entire
used

E-minis

the

POV

large
with

(SEC)

the
on

significant

POV
May

POV

volatility

set

report

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2010.

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50

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Gatheral
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Wang

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details.

(2011)
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the

form,

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market

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(23)
where

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(25)

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(26)
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original

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for

the

execution

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[equation

(21)]

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(27)
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into

the

volume

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equation

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produces

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result:

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u t can

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(29)
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resiliency

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as

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be

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is

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of

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at

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trading

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for

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T =1
in

and

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for

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15.17

different

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trading

frequencies.
Figure

15.17

Market

Impact

Source:

Optimal

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and

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Exponential

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in

a Market

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with

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with

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(32):

(32)

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function

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15.18

15.19

Optimal

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z.

singular

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at

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15.19

Market

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and

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restored,
and

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a Market

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the

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remedied?
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is resilience

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TWAP,

VWAP,

and

POV

be

CHAPTER

16

Implementation

of HFT

Systems

High-frequency

trading

(HFT)

applications,

comparable

launches

and

practices

of implementing

Model

having

HFT

systems,

by

making

and

typically

outperform

tasks,

are

to

typical

life

16.1

mission-critical

This

NASA

chapter

reliable

HFT

shuttle

describes

best

systems.

nature,

require

in these

treacherous

example.

hesitation-free

programmed

traders

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rapid

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traditional

a result,
human

decision

computer

systems

mission-critical

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conditionssee

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traders

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development

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be

piloting

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Figure

Figure

16.1

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ABOUT

THE

IRENE

AUTHOR

ALDRIDGE

recognized

is an

expert

high-frequency

on

Industry

Finance

and

Risk

LTD,

vehicle

specializing

strategies.

an

At

advises

and

trading

in

venues

and

of

trading

runs
the

continuously

updated

hundreds

of

has

Committee

High-Frequency
holds

Columbia

called

panels,

Futures

for

Goldman

been

for

has

Future

Trading

regulation
is

also

the

latest

institutional

market

developed

been

broker-dealers.

and

is

well-received

upcoming

various

by

schedule

institutions

Sachs
to

and

the

Computer

Commission's

on

CIBC.

contribute

including
of

design,

making
and

on

of

at HFTtraining.com.

worked

including

pools)

and

for

The

is available

Aldridge

regulatory

Commodity

from

Alpha,

in Toronto,

government

Aldridge

professionals.

entities

strategy

was

and

and
Aldridge

Aldridge

program

program

trading

dark

investors

training

Aldridge

worldwide

Aldridge

Foresight

by

industry

to ABLE

years,

HFT

first-of-it-kind

sessions

and

an

and

resource

institutional

trading

duties,

management

online

Alpha

government

operations.
an

for

funds,

risk

ABLE

implements,

high-frequency

low-frequency

participants;

Street

optimal

at

of her

exchanges

systems,

research

Aldridge

Prior

and

as

well

high-frequency

part

hedge

(including

AbleMarkets.com,

high-frequency

As

as

a proprietary

designs,

strategies.
large

research

high-

and

Aldridge

broker-dealers,

of

training

Alpha,
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of

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quantitative

of

Manager
and

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Department

Institute,

firm

and

Aldridge

University,

Portfolio

investing

educator.

York

consulting

manager,

quantitative

seasoned

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portfolio

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investment

implementation

founder

at

of

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ABLE

high-frequency

both

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proprietary

also

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and

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consultant,

subjects

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Partner

deploys

the

trading,

currently

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investment

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to
U.K.

Trading

Wall
the

numerous
Government

and

the

U.S.

Subcommittee

on

Trading.
an

MBA

University,

from

INSEAD,

and

a BE

an

MS

in electric

in financial
engineering

engineering
from

the

Cooper

Union

completing

her

speaker

at

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to

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continuous

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business
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has

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networks,

German

economic
radio.

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television

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Bloomberg

Times,

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presently

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media

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York

events

appears

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mainstream

FXWeek,

Aldridge

Daily

at

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Huffington

York,

industry

and

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New

PhD

top

practitioner
of

in

Press,

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news

outlets.

community,
Hill

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and

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of

ABOUT

THE

This

book

The

web

materials

WEB

is

accompanied

site

supplements

like

PowerPoint

related

materials.

register.

Once

latest
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activity
receive

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in the
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high-frequency.

the

web

site,

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site

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subscribers

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www.hftradingbook.com

materials

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registered,

www.hftradingbook.com
enter

SITE

valid

also

with

.
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e-mail

address

receive

and
to

updates

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the

web

site

at

space.

free

benefits,
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When

visit
prompted

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for

book's
a

password,

please

REFERENCES
Agarwal,

V.

and

Involving

Hedge

Aggarwal,

N.

and

Announcements
Rates,

and

Finance

Ahn,

H.,

11,
K.

Volatility:

Ajayi,

Asset

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trading.
Future

Working
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Computer

2011.
paper,

UK

Trading

INDEX
Administrative

and

legal

costs

Algorithms
common

elements

critical

of

lineoptimizing

execution
genetic
order-routing
maximize

execution

maximize

trading

minimize

execution

minimize

footprint

obtain

best

size
costs

price

time-weighted

average

volume-weighted
sample

speed

price

average

(TWAP)

price

(VWAP)

market-making

Algorithmic

trading

Alpha
Alternative

investments

Arbitrage

strategies

Automated
Average

market-making

strategies

gain/loss

Back-test
Basis

trading

Bayesian

approach

Benchmarking.

See

Beta
Bid-ask

spread

tightness

of

Bollinger

bands

Broker
Burke

commissions
ratio

Performance

attribution

Calmar

ratio

Cancel

orders

Capacity

on

system

disconnect

evaluation

Capital

asset

pricing

Central

processing

model
unit

(CAPM)

(CPU)

Cointegration
Commodity

Futures

Trading

Commodity

markets,

event

Comparative

arbitration

ratios

Complex

orders

Conditional

Sharpe

ratio

Connectivity,

cost

of

Convergence

and

divergence,

Core

Commission

market

engine

Correlation
Counterparty
Credit

risk

Cuban,

Mark

Custody
Dark

risk

and

clearing,

cost

pools

Data,

costs

of

administrative

and

legal

connectivity
custody

and

electronic

clearing

execution

hardware
software
staffing
Data

set

Direct
DirectEdge
Directional

testing

access

to markets

exchange
traders

of

(CFTC)
in

Directional
event

trading

arbitrage,

commodity

around

events

application

of

markets

emerging

economies

equity

markets

fixed-income

markets

foreign

exchange

futures

markets

real

estate

markets

investment

trusts

(REITs)

events
forecasting

methodologies

strategies,

developing

tradable

news

corporate
industry
macroeconomic
Discrete

pairwise

(DPW)

optimization

Drawdown
Electronic
cost

trading

of

Emerging

economies,

event

arbitration

in

Equities
arbitraging

different

classes

fragmentation

in

large-to-small

information

Equities

( continued

liquidity
pairs
risk

issuer

spillovers

arbitrage
trading

arbitrage

Equity

markets,

Evaluation
Event

of same

period,

arbitrage.

event

arbitrage

length
See

also

in

of
Directional

trading

around

events

Excess

return

Exchange

on

value

at risk

fees

Execution
aggressive

vs.

passive

process
speed

of

Exponential
Field

market

resiliency

programmable

gate

Fill-or-kill

orders

Financial

Industry

Financial

Information

First-in-first-out
Fixed

Foreign
event

Authority

eXchange

(FIX)

execution

fragmentation

Fixed-income

(FPGA)

Regulatory

(FIFO)

income,

array

markets,

triangular

in

event

arbitration

Forex,

in

arbitrage

uncovered

interest

parity

fragmentation

in

Fournier

arbitrage

analysis

Front-running
Fundamental

analysis

Futures
arbitrage
fragmentation

in

Futures

Industry

Futures

markets,

event

Gambler's

Ruin

Problem

Geometric

Brownian

Graphics
Hardware
cost

of

Association

processing

(FIA)

arbitration

motion
unit

protocol

schedule

exchange
arbitration

(FINRA)

(GPU)

in

in

history

of

Hedging
delta
portfolio
High-frequency

data

bid-ask

and

bounce

buy-and-sell

identifiers,

lack

of

defined
deviation

from

irregular

spacing

properties

normality

of

recording
volume
High-frequency

trading

capitalization

(HFT)

of

defined
economics

of

costs

of doing

costs

of data

event

arbitrage

as

evolution

financial
key

business

of trading

markets

processes

leverage
number

methodology

suitable

for

of

of
of traders

participants

in

competitors
government
investors
service
risk

and

technology

management

strategies,

of.

performance

providers
See

Risk
and

management
capacity

of

alpha

decay

basic

performance

capacity

measures

evaluation

comparative

ratios

evaluation

period,

measurement,

length

principles

performance

implementation

common

pitfalls

key

steps

High

life

cycle

in

trading
water

Hurst

of

in

development

testing

of

attribution

systems,

model

of

systems

mark

exponent

Iceberg

orders

Ignition
Integration

testing

Interactive

Brokers

International

Organization

Internet

communication

Interval

price

Investor

of Securities
models,

limits

Commissions

common

(IPLs)

protection

front-running
intentional
market

market
crashes,

manipulation,
predicting

based

on

abnormal

based

on

asymmetry

Jensen's
Kappa
Kill

alpha
3

switches

Knight
Kurtosis

Capital

detecting

Group

trading

patterns

of liquitidy

in limit

order

books

(IOSCO)

Kyle's

lambda

Latency

arbitrage

strategies
Latency
Law

costs

of One

Price

Layering
Lee-Ready
Legal

rule

entity

Limit

identifiers

order

Linear

(LEIs)

books

market

resiliency

Liquidity
Liquidity

arbitrage

Liquidity

risk

Lit

pools

Low-latency
Lower

trading

partial

Machine

moments

(LPMs)

learning

Market

crashes,

predicting

based

on

abnormal

based

on

asymmetry

Market

impact

trading

patterns

of liquidity

in limit

order

books

(MI)

costs
estimation

of

minimizing
advanced
basic

models

models,

execution
optimal

issues

algorithms
execution

order-routing
permanent,
basic
data

with

strategies,

practical

algorithms
empirical

estimation
preparation

model

estimation

of

implementation

of

Market

makers

Market

making,

data,

automated

information

market

does

market

moves

quotes

widen

trade

not

information

evolution

in order

of order

of tick

data

of order

as
as

book

flow

flow

aggressiveness

shape
key

rebounds

markets

autocorrelation

order

move

and

moves

modeling

in

as

as

predictor

predictor

of market

predictor
predictor

of market

of market
of market

principles

nave
fixed

strategies
offset

order-arrival

rate,

offset

trend-dependent

as

function

of

offset

volatility-dependent

offset

profitable
as

a service

bid-ask

spread,

block

tightness

transactions,

market

depth

market

resilience

order

book,

order-flow
price

price

at best

shape

per

technical

support

strategy,

simulating

Market

manipulation,

Market

orders

Market

risk

bid

sensitivity
and

to

best

ask

of

imbalance,

change

of

price

sensitivity

unit

volume

and

resistance

detecting

levels

to

movement

movement
movement
movement

critical

lineoptimizing

discrete

pairwise

genetic

algorithms

algorithm
(DPW)

optimization

hedging
delta
portfolio
nonlinear

programming

simultaneous
stop

equations

losses

determining

parameters

value-at-risk
volatility

(VaR)
cutouts

determining
ex-ante
Market
lit

structure

and

swap

dark

pools

execution

facilities

Markets
microstructure

of

aggressive

vs.

passive

complex

orders

equities,

fragmentation

forex,

fragmentation

fixed

income,

futures,
limit
market
options,

convergence
fragmentation
fragmentation

trading

hours

modern

in
in

in

books

swaps,

types

in

fragmentation

fragmentation

order

execution

of markets
vs.

past

and
in
in

divergence

financial

landscape

HFT

as

HFT

participants

of the

evolution

media,

of trading

modern

of high-frequency

Markov

state

and

HFT

traders

dependency

quantity

Merrill

methodology

markets,

number

Maximum

1970s

limits

Lynch

Message

acknowledgment

Message

throttle

loops

limits

Messaging
core

architecture

network

throughput

protocols
Financial
User

Information

Datagram

Protocol

Transmission
speed

Protocol/Internet

Protocol

(TCP/IP)

security

Sharpe

Moving

average

National

Best

New

(FIX)

(UDP)

Control

and

Modified

eXchange

York

ratio
convergence
Bid

Stock

No-cancel

and

Offer

Exchange

divergence
(NBBO)

(MACD)

rule

(NYSE)

range

G
Omega
Opportunity
Options,
Order

costs
fragmentation

flow,

modeling

autocorrelation
evolution

in

of tick

adverse

selection

effective

bid-ask

information

of order
data

as

flow

predictor

components
spread

as

in
predictor
of market
of bid-ask

of market
movement
spread

movement

information-based
quoted

impact

bid-ask

order

spread

aggressiveness

shape

of order

Pairs

as

book

as

predictor
predictor

of market
of market

movement
movement

trading

Paper

trading

Parametric

bootstrapping

Performance

attribution

Performance

measures,

alpha

and

average

basic

beta
gain/loss

correlation
drawdown
return
skewness

and

kurtosis

volatility
win

ratio

Phishing
Pinging
Post-trade

analytics

Power-law

market

resiliency

Prehedging
Price

appreciation

Price

reasonability

Price-time

priority

and

timing

risk

costs

execution

Production
Protection

points

Pump-and-dump
Quote

archival

Quote

matching

Quote

stuffing

Real

estate

investment

trusts

(REITs),

event

arbitrage

in

Real-time

position

Rebate

validation

capture

Rebates
Regulation
global

key

initiatives

efficient

trade

matching

investor

protection

jurisdiction
market

structure

stability

of systems

Return
Risk

arbitrage

Risk

management

measuring

HFT

credit

counterparty

and

risk

market
liquidity
regulatory

and

legal

Securities

and

Exchange

Securities

Information

Sharpe

Commission
Processor

ratio

conditional
modified
Simulation
back-test
paper

trading

production
Simultaneous
Skewness
Slippage
Sniffing
Sniping

equations
and

kurtosis

or latency

costs

framework,

(SIP)

(SEC)

Software,

cost

Sortino

of

ratio

Spaghetti

Principle

of Modeling

Spoofing
Spread

scalping

Staffing,

cost

Statistical

of

arbitrage

models
practical

applications

of

cross-asset
equities
foreign

exchange

general

considerations

indices

and

ETFs

options
Sterling
Stop

ratio
losses

determining

parameters

Supervision,

human

Surveillance

measures,

kill

near-term

switches

legal

entity

Swap

identifiers

execution

facilities

Swaps,

fragmentation

System

testing

graphical

user

interface

recovery
reliability
scalability
security
stress
usability

and

(LEIs)

performance

in

(GUI)

software

Systematic

trading

Taxes
Technical

analysis

Technological
hardware,

innovations
history

of

messaging
core

architecture

network

throughput

protocols
speed

and

security

software
Tick

data.

Tick

rule

Time

See

High-frequency

distortion

Time-weighted
Trade

average

matching,

Trading

execution

(TWAP)

efficient

and

execution

bid-ask

spreads

market

impact

opportunity
price

definitions

costs,

implicit

overview

costs

costs
and

or latency

market

impact,

permanent

of

costs

appreciation

slippage

data

price

costs

background

basic

data

estimation
impact,
model

preparation

transparent
broker
exchange

execution

commissions
fees

risk

costs

costs

market

estimation

timing

costs

of
empirical

estimation

of

taxes
Trading

hours

Trading

systems,

data

set

testing

integration

testing

system
unit

testing

testing

testing

use-case

testing

Transmission
Treynor

Control

ratio

Triangular

arbitrage

Uncovered

interest

Unit

Protocol/Internet

parity

arbitrage

testing

Upside

Potential

Use-case
User

ratio

testing

Datagram

Value-at-risk

Protocol

(UDP)

(VaR)

Volatility
Volatility

cutouts

determining
ex-ante
Volume-weighted
Wash
Win

trades
ratio

average

price

(VWAP)

Protocol

(TCP/IP)