DislikedIf this is the case, how is it possible that 1 dealer could be stuck on the wrong side of the market and manipulate prices to get himself balanced before moving back in the right direction? Maybe the dealers work together?Ignored
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DislikedIf this is the case, how is it possible that 1 dealer could be stuck on the wrong side of the market and manipulate prices to get himself balanced before moving back in the right direction? Maybe the dealers work together?Ignored
DislikedI was thinking about this a lot while reading the dealers chapter this weekend. What I could not reconcile in my mind is how this works in the fx market, where there are several dealers setting market prices (correct assumption?). We know if there are multiple dealers dealing similar instruments (in fx case identical), their bid and ask quotes have to be close to each other, otherwise arbitrageurs would take advantage of the differences between dealers (correct assumption?).
If this is the case, how is it possible that 1 dealer could be stuck...Ignored
DislikedHow do you know they are ever on the wrong side of the market. For Example, In T&E page 283,"Dealers who hold no inventory avoid the costs of financing there positions, they do not lose when prices move against them."...Ignored
DislikedI don't have an answer for you. I am thinking this is going to take a long time to get to a point of understanding.Ignored
DislikedGuys, if you want to know how fx dealers work, rather than just guessing read Osler and Lyons, and other papers that deal with how fx dealers manage inventory (there are a good number of them if you search). T&E is good generically but not enough if you're interested specifically in fx dealers.Ignored
DislikedFunny you would mention that because the section of the book dealing with reading orderflow opens with an extenisve discussion of game theory. However, game theory, as it is traditionally applied, is basically useless for financial market speculators because there are far too many participants acting simultaniously over an infinite number of moves.
The value of game theory is in the process by which games like the prisoners dilemma are solved. It's all about using inductive reasoning to work out the consequences of participant motivations....Ignored
Participants will not want to sell for a lower price than they can buy at, and conversely they will not want to buy at a higher price than they can sell. This leads to a small gap in between the bid and the ask, called the spread. The market is defined as being bound by the bid and the ask.
But how can participants let it be known that they are willing to buy and sell at given prices? This is done through the issuance of limit orders. This disclosure of participants of their willingness to trade at particular prices, constitutes liquidity. Liquidity can be thought of as the concentration of limit orders at a particular price or price region. When liquidity is described as high or deep, it means that several limit orders exist at a particular price or price region, waiting to be executed. Conversely, when liquidity is described as thin or low, it means that the concentration of limit orders at a particular price or price region is lacking.
Liquidity is important in financial markets, because it enables participants to conduct transactions of size quickly and efficiently, allowing them to have their order filled as close to their desired value as possible. Liquidity is the parameter which allows for the possibility of identically sized orders to have significantly different impacts on price.
Thus we see that liquidity, issued in the form of limit orders provides a sort of framework to the market, by communicating prices at which individuals are willing to buy and sell. Limit orders will be either buy limits, the best one being the bid, and progressively lower ones accumulating behind it; or sell limits, the best one being the ask and progressively higher ones accumulating behind it.
Limit orders however can only be satisfied via the issuance of market orders. A buy market order executes at the ask, and a sell market order executes at the bid.
MARKET ORDERS AND LIMIT ORDERS ARE ESSENTIALLY THE TWO FUNDAMENTAL ORDER TYPES WHICH DRIVE MARKETS. All other order-types are more or less modifications of them.
Imagine the following ask region in a fictitious market:
Jane - 200 contracts - 1.4000
Mike - 200 contracts - 1.4000
Sue - 600 contracts - 1.3500
Ron - 300 contracts - 1.3000
The first thing to notice is that participants can issue limit orders at the same price, and the orders will be filled in the priority in which they were issued by the participants. Thus Mike's contracts will be sold before Jane's since he issued the orders before Jane, even though they are at the same price.
Secondly the only way Mike's contracts can be sold, is if he waits for all of Ron's contracts followed by Sue's contracts to sell, or if he removes his order and relists it at 1.2999.
John comes along and desires to purchase 1000 contracts of the instrument. The ask is 1.3000 when he executes his buy market order to do so. He will first consume all the liquidity provided by Ron (300 contracts) at 1.3000, causing the ask to now become 1.3500. He will then consume all the liquidity provided by Sue (600 contracts) at 1.3500, causing the ask to now become 1.4000. He will then consume 100 of Mike's contracts at 1.4000 to complete his order, leaving 100 of Mike's contracts on the market, and thus the ask remains at 1.4000. Thus the instrument moved from being sold at 1.3000 to now being sold at 1.4000.
[NOTE HOW MIKE'S ORDER HAD TO BE SPREAD OUT AND HIS AVERAGE FILL ENDED UP BEING MUCH GREATER THAN THE 1.3000 HE ANTICIPATED. THIS EMPHASIZES WHY AREAS OF LIQUIDITY ARE PARTICULARLY IMPORTANT TO PARTICIPANTS OF SIZE]
Participants may then issue new limit orders ahead of Mike, if they desire quicker execution, and do not want to sell all the way at the bid, which is let's say 1.2000. This would result in the ask being brought back down.
However, when there is buying pressure to the upside (ie. sell limit orders are being consumed), we will often see new buy limits being issued as the ask moves up, and thus the bid would appear to follow the ask. Sellers seeing prices moving upwards, would be tempted to sell for more, and buyers would be willing to buy at these higher prices, knowing that they can sell for more. Price in general, would thus be rising. The opposite scenario also holds when price is falling.
You have to be able to superimpose the constant addition and removal of limit orders on the actual execution of orders, to be able to accurately envision what I'm talking about. I know you have seen the D.O.M recently Carnegie, so I'm hoping this would be a bit easier for you to grasp. However the D.O.M will not show you whether movement in the bid/ask was due to the execution of orders or whether it was due to removal of limit buys/sells; removal of liqudiity. Both of these will cause movements in price, if the latter represent the bid or the ask.
To distinguish between the two, we would have to use what is known as "Time and Sales".
As shown in the simplified example, different individuals will have different interpretations as to the 'perceived value' of the instrument, leading to a liquidity distribution which approximates the diagram which Darkstar uploaded for us in the other thread. This is because participants will want to buy low, when the instrument is undervalued and sell high, when the instrument is overvalued.
I know the explanation may be rushed and I may be leaving out a few key elements, but I've tried to compress it to a nutshell because I have other obligations to attend to. In my opinion, the three important thing I was able to grasp from understanding microstructure were:
Hope this may help you in any way possible,
Regards,
xXTrizzleXx
DislikedI KNOW WHAT YOU ARE TALKING ABOUT!!!!! (I think)
If you say that it is too many participants and infinite numbers of "plays". Then the only way game theory can be applied in this is with outcome and probability of the outcome!!
Am I right Darkstar? If so it's a breakthrough!!
Please someone help me out here!Ignored
DislikedYou can use Bayesian Equilibrium for the outcome of the game scenario, but thats a later stage problem.
Before you can solve the game you need to define the scenario. Who are the participants? What are their objectives? What strategies are they using? How much of the global information set do they have access to?
Inductive inference is the mechanism you use to establish the answers to these questions.Ignored
DislikedAnd we all know that the big players need liquidity to enter the market, and stop hunting is a way to find the needed liquidity.
Is there another method they use to find liquidity?Ignored