Market-Making Algorithms

A market maker stands ready to buy and sell at publicly quoted prices. An algorithm can automate the decision to post, update or cancel bid and ask orders, but the economic task remains to manage risk while supplying quotes. The strategy may seek to earn some of the bid–ask spread or exchange rebates, yet it can lose money if prices move against the inventory or informed traders execute against stale quotes. A quote engine can consider the current book, recent trades, volatility, inventory, fees and limits. If a market maker accumulates too much of an asset, it may skew quotes or reduce size to manage exposure. If adverse-selection risk rises, the system may widen or withdraw quotes. Some exchanges designate market makers and impose quoting obligations; other firms use market-making strategies without that formal role. Rules depend on venue and product. Market-making is one type of strategy that can be executed at high speed, but “market maker” and “HFT” are not interchangeable categories. Evaluate a strategy with more than gross spread capture. Account for fills, cancellations, inventory revaluation, fees, rebates, hedges, market impact and capital use. The SEC describes market makers as firms that stand ready to buy or sell at quoted prices and publishes market-structure material on liquidity and order execution. A simulated quote strategy does not guarantee continuous liquidity or profits in live markets.