You're very welcome. No, I just researched the subject out of curiosity. Like someone here already said, the barrier to entry for this kind of business is very steep. On the other hand, for a smaller operation, it's possible with lower volume stocks where the bigger HFT firms aren't interested, together with hedging the MM operations with correlated instruments. You might be able to get a shot at it. Still, not trivial to set up and you need a starting capital to take the initial losses.
Yes I think you are right on with this as well. I am in fact looking into this and so far it appears opportunities are few and far between, but I think they do exist and are very likely exploitable... One question: you mentioned the larger firms are interested in lower priced instruments (around $20) due to costs involved -- it seems to me higher priced stocks give a better commission ratio. Am I missing something here? Thanks again.
If your commissions are flat, then making 0.01 / 20 becomes larger than 0.01 / 100. To put it another way ⦠cent-per-share commissions suck donkey balls.
I see, that makes sense -- but if your commission is per share (my case at IB), then its the other way around right?
That's because of the spread. If the bid/ask is 1 tick, which is 0.01, for the $20 stock that is a 0.05% per round trip. For the $500 that is 0.002%, and this may not be enough to pay for costs. Obviously, for $500 stocks, the spread is never 1 tick wide due to HFTs, but some larger value like i mentioned for AAPL.
Got it that makes sense too. If you are assuming a 1 tick spread yes that's true. If you look for very illiquid instruments however, the spread often is proportional to the price (e.g., $300 instrument might have 10 cent spread, whereas $10 instrument might be down to one or two pennies) so in those cases I am seeing that higher priced instruments give you more spread to earn... But of course those have such low volume that the institutions are likely not interested.
Not really. Say for example that the comission is 0.03 %. Any spread that is less than that isn't worth it. If you went from lower to higher priced instruments, you'd see the spread is around that value, in my example 0.03%. This in essence means that the size of the spread we get on the markets is dictated by how low the commission is that the exchanges can offer. The lower the commission, the lower the % they can use to make profits. When 1 tick is less than that value, you need a spread of at least 2 ticks to make the minimum profit (in % terms) to be in business. Then, if you have a spread that's 2 ticks, anyone can place a bid/ask between that and re-tighten it, making it unprofitable. So the fact that higher priced instruments have a larger spread isn't due to low intrest from the institutions, it's actually the direct consequence of the cost of the lowest commission (and highest rebates) available to the market makers.
Yes I agree that the spread is not due to the low interest from institutions. I was thinking that in the absolute spread sense, the higher priced stocks will get you more spread because of the fixed percentage you mentioned (i.e., 0.03% of 200 is wider than 0.03% of 20). Also, I keep thinking about my own commission structure which is per share at IB, so a higher priced stock actually is cheaper for me to buy and sell (because I need to buy / sell less shares to get the same dollar amount). But for a flat fee commission, yes the lower priced stocks will be cheaper I agree.
The point here is that the latency arbitrage traders are co located at the exchanges. They see the order flow before any one else by milliseconds. The NBBO is a national system. Each exchange is linked to and updates the NBBO. ARCA, NYSE, BATS, EDGX, NSX, CIN, UBSS, NSDQ, etc etc... Each exchange offers co location services. So these Algo traders see the quote data before the national system. These arbitrageurs as market participants, who are able to know that an order will move the NBBO into a certain direction, before this fact is reflected by the NBBO (because it takes time to discern the NBBO). Based on this knowledge, they trade against any existing liquidity at the (stale) price which is still being displayed and offer these securities to the trader who initially caused the move in the NBBO. To profit from this, the arbitrageurs will offer the securities at a higher price, in case of an incoming buy order, or respectively at a lower price in case of an incoming sell order. And most traders do not use smart routing. Smart routing is something that retail brokers offer for convenience. Just go to the BATS or DirectEdge websites to see all the different order types available. It will give you an idea on how many options there are as far as order types and routing. http://www.directedge.com/Portals/0/docs/NextGen Guide to Order Types.pdf