[AllanHoustonSt]

Traders (be it hedge funds, props, retail, anyone) will only "take your action" if you price competitively. You'll never get your orders filled. The open bid and ask as per whatever the exchange quotes are really the only prices that matter when it comes to what actually gets executed.

Also even if you do quote wider, to effectively capture the spread, your buy on one side and your sell on the other side still have to basically occur simultaneously which is where the demand for latency comes in so you really can't escape it.

That said there are ways to still be profitable even if you know you're not the fastest gun in the west across the most exchanges. Without going into too many details you'd have to selectively choose where/what you trade. Which is not trivial at all of course.

[gas9S9zw3P9c]

Hm, maybe I'm fundamentally misunderstanding something. Let's just say the price is a random walk. It's not directly relevant to the argument, but for simplicity. An HFT MM will make money by continuously quoting ask/bid at the best price, i.e. a lot of trades, capturing a very small spread each time. Given that it's a random walk, buy and sell don't always occur simultaneously either, e.g. in a trending regime where the HFT MM may start pulling quotes due to risk checks and/or inventory/hedging concerns.

So if I am an MM that quotes a wider but gets fewer executions at larger time intervals, shouldn't I be able to also make profit? After all, my queue position is in front of the HFT MM because I put in orders earlier (since I am quoting wider), latency here is irrelevant.

Can you explain where my logic is faulty?

[AllanHoustonSt]

I guess I would say, it depends?

Existing profitable MMs aren't all equally fast. So the slower ones that trade on the same exchanges or even the same indices have to be profitably trading at a wider spread.

HFT isn't a concrete term so I guess technically there's no hard line to draw for how fast your roundtrip times have to be to be profitable. But if you are trading wide enough where you think latency isn't a factor, aren't you really just predicting where you think the book will go "far" ahead in the future? MM is inherently a reactionary business (with some effort put into anticipating the price moving against you in the very very short term).

[gas9S9zw3P9c]

> But if you are trading wide enough where you think latency isn't a factor, aren't you really just predicting where you think the book will go "far" ahead in the future

Yep, or rather, predicting where the market will not go to avoid the price moving against my quote. My impression was that HFT is all about being fast, as opposed to smart, since you can't make complex predictions on nanosecond scales. Complex models don't fit on an FPGA. So couldn't you get an edge by being just a little bit smarter with predictions but slower and quoting wider spreads? And just to be clear, I'm not talking about minutes here, but maybe milliseconds to seconds, which I think wouldn't be considered HFT today?

[AllanHoustonSt]

There is trading activity in the milliseconds-seconds horizon as well. I'm sure all the big HFT players participate plenty. These just wouldn't be considered MM strategies.

Your original question was why MMs have to operate at HFT horizons. MMs by definition are liquidity providers (which means high availability and high volume at competitive prices). In some cases (DMMs) they're legally obligated to do so at some well defined baseline. And in that specific context HFT speeds are required.

[gas9S9zw3P9c]

To me, MM is the activity of providing liquidity with passive buy and sell orders - profiting from the spread while taking on inventory risk. That's also how exchanges define it, paying (or giving discounts to) traders whose orders are filled passively - the whole maker/taker incentive that was invented to attract customers a few decades ago. And we had human market makers well before electronic markets, and we still have them for illiquid markets today. They are (still now) called Market Makers even though they trade on minute scales!

So why is it not considered Market Making if I make decisions on millisecond or second scales? I don't understand how that is related to time horizon. So that's what I meant with original question, why can't I be a profitable market maker without HFT speeds? I still don't see the reason... Or are we just arguing about definitions here? Maybe when you say MM, what you really mean is HFT, but in my head the taxonomy looks completely different.

DMMs are a different story since that's basically just an SLA you have to adhere to, but not talking about DMMs in this case.

[1e-9]

Slow market making is still market making, although rarely a good idea in my view. There are instruments with market makers operating at millisecond time scales. Not nearly as many as a few years ago, but they do still exist.

[JoshuaDavid]

> Let's just say the price is a random walk

This is where your logic is faulty. On the time scale of for example days, the price is definitely not a random walk. If stock XYZ has a price of $100 at 9:00 am, and you put in a buy order at $99.50 and a sell order at $100.50, there are a number of ways for it to go:

1. The price drops to $99, your buy at $99.50 triggers and you now are long (expect the price to rise), the price rises to $101, your sell at $100.50 triggers, you make $1.00 and are back to your original position.

2. The price rises to $101, your sell order at $100.50 triggers and you are now short, the price drops to $99.00, your buy order at $99.50 triggers, you make $1.00 and are back to your original position

3. The price drops to $99, your buy at $99.50 triggers and you now are long (expect the price to rise), the price continues to drop to $95, you now have a share of XYZ worth $95.00 which you are offering to sell at $100.50. Either you exit your position (and lose $4.50) or stay in the position (in which case you have $99.50 less available to invest than before. Whether or not the position makes sense to keep, you are now a long-term investor, not a market maker.)

4. Same as number 3 except that the price rises to $100.50, your sell goes and you are now short XYZ, the price continues to rise to $105.00 and again you either exit the position and lose money or don't exit and are long-term short XYZ (and never make the money back if the price never drops back down).

In order to make a profit, 1 and 2 have to happen 10x as often as 3 and 4 for the particular values mentioned above.

If you widen your spread, you will make more money each time the random walk of the market goes from one side of your spread to the other, but that will happen less often (whereas large one-way market moves that more-or-less permanently move the price to a level where it no longer crosses your spread stay roughly as probable as before).

If you narrow your spread, you will make money more often, but less each time. HFT firms are an extreme example of this - they have very (very!) narrow spreads that they trade on millions of times per second, pocketing a fraction of a penny each time (unless the market moves, in which case they lose money just like any other market maker, but events that happen every minute are "rare" when you are working on the timescale of microseconds).

There is a phrase, "picking up pennies in front of a steamroller", used in finance. The basic idea is that there are pennies (spreads) lying on the ground for you to pick up, but the steamroller (an actual movement of the market) could come along at any time and crush your profits.