1/ This is a common fallacy! Just because you cross a wide spread when using a market order, doesn't mean you should place resting limit orders. If you do this, good chance you are burning money. Let's use some HFT thinking to help all types of traders 🧵
2/ A simple example: token X is trading with best bid $99 and best offer $100. Let's assume fees are much less than 1%. You think the fair price of X is $101. If you buy now at $100, you make $1 on average. Simple enough.
3/ "The spread's so wide though," you think. How about a limit order to buy at $99? $101 - $99 = $2, so did you just double your expected pnl? No, because you might not get filled. If the price moves straight up, you miss your fill. Straight down, you get a fill but lose money.
4/ In trading terms, resting orders are subject to "adverse selection." Just like in poker, if you make a bet, you tend to get called by better hand than those that fold. So, if you have a good price signal, you probably want to keep it simple and just cross the spread.
5/ Not convinced? There are many more cute arguments that non-HFT (including most quant trading) should probably cross the spread. On average, the profitability of resting orders depends on their place in queue. This latency race is winner (i.e. HFT)-take-all. Read more here:
6/ Take a random point in time. Chances are, not much is happening (volatility is autocorrelated in time). Anyone crossing the spread then, whether you or Citadel, has basically the same access. Symmetry. But no one can cut the line to place resting orders. Asymmetry.
7/ More salt on the wound for limit orders: By placing limit orders, you inform algos that you want to trade, and they will frontrun you (ahem, to better provide liquidity). When you place a market order, assuming you got your full size, you're done.
8/ Don't totally dismiss resting limit orders though. What are some exceptions? If your fees are very skewed, e.g. 0 maker fee promotion when your taker fee is 0.1%, then you have to think about fee vs your expected edge. Modeling the adverse selection is for another thread...
9/ There are obviously strategies that do benefit from resting orders. But blindly placing resting orders at top of book is likely a recipe for bad fills and bleeding pnl. E.g. providing far-out liquidity for large wicks. Totally makes sense to use resting orders there.
10/ Appendix: this analysis is about making vs taking, not limit vs market. You should probably have limit prices on all your orders just in case. We focused on executing one hypothetical order. If you're trading large size, you execute in pieces (topic for another thread)
11/ Conclusion: there are multiple order types for a reason. Hopefully this thread makes you think about markets from first principles and in the context of your specific strategy. Don't blindly follow advice, think for yourself!
@chameleon_jeff A trader once gave me the sage wisdom "don't be a dick for a tick"
@chameleon_jeff I have been saying this for years, with limit orders you playing the queue game and competing with the fastest in the space. In the think the bias is so prevelent because orderbooks where thicker before
@chameleon_jeff @threadreaderapp unroll #HFT