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Using Directional Signals to Adjust Market-Making Quotes

Article Quant Q&A · Author: wildbunny
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Summary

The document asks how a two-sided market maker can use a signed forecast of the next price movement, expressed in ticks, to reduce exposure when prices begin to trend. Its concern is that adverse directional moves can make inventory losses grow faster than the ordinary gains from providing liquidity. The proposed warning mechanism is intended to identify when quotes should be withdrawn on the side most exposed to the predicted move.

The responses offer brief, qualitative suggestions: cancel orders on the side indicated by a sufficiently strong signal, or trade aggressively at the top of the book if the forecast is reliable. They do not define how to calibrate the signal threshold, measure prediction quality, or weigh missed fills against adverse selection and inventory risk. There is no empirical evidence, model, or performance comparison, so the ideas are starting points for quote management rather than a validated strategy. A practical design would need to account for execution costs and the possibility that the signal is wrong or arrives too late.

Key ideas

  • A market maker exposed on both sides can face losses when prices trend against its inventory.
  • A signed forecast of near-term price movement could guide which side's quotes to cancel.
  • The response suggests acting when the directional signal is strong enough, without specifying a threshold.
  • A reliable forecast might also support taking liquidity at the top of the book.
  • The document provides no empirical validation or detailed risk trade-off analysis.

Tags

Market makingMarket microstructureExecutionMomentum
Full text
# Predicting microstructure momentum in market making


# Predicting microstructure momentum in market making












If I have a market maker which is compelled to provide quotes on both sides of the market, I am exposed to risk of quadratic losses (vs my linear gains during normal operations) during times when the market is trending.

Therefore it is imperative that I know when to 'get out' of a bad position just before the market starts to trend.

Assuming I have a signal which gives me a signed prediction for number of ticks of the next movement, how do I build such a warning mechanism?

## Answer by Ezy (score 1)

https://quant.stackexchange.com/a/43921

If your signal is good then you can cancel your orders on the side the signal indicates when it is big enough

## Answer by user123123 (score 1)

https://quant.stackexchange.com/a/44296

Get better signals. If you know its going to move, then smash top of book

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.