How to Make Money in The Market: Providing Liquidity

Martinghoul's picture
Rank: Neanderthal | 3,640

Since you brought it up - what is your edge?

I am really a liquidity provider of last resort, with occasional forays into macro.

Certainly lots of people can or are willing to provide liquidity in your world, no?

So let me start by saying that I believe that there are only two ways of making money in the mkt. They are:

**A) accurately predicting the future; and B) providing liquidity.**

In the famous words often attributed to Mark Twain, "it's difficult to make predictions, especially about the future". Moreover, it's even harder to make such predictions in the mkt, where you have to not only be right about the future, but also about when this future will be realized. On top of that, you have to make sure that you survive all the mkt fluctuations in the interim. So method a), which is what most people refer to when they talk about "old-school" macro, is really really hard, especially in this day and age. On the other hand, b) is kinda hard, but it's not really that hard.

So, based on the above, my edge is using distortions in the rates mkts (created by large, somewhat price-insensitive flows) to put on trades, which allow me to make bets on the future with favorable risk/reward characteristics. If you're careful and diligent and have some experience in these things, you could construct a "neutral" portfolio that should perform in a majority of future scenarios and, most importantly, will be relatively timing-insensitive. This, I guess, is sorta similar to the basic premise behind a typical long-short equity book. It's the "relative value" element, if you will. Furthermore, if you do feel the urge to actually bet on a particular future outcome and you have a selection of trades to play with, you can also adjust the relative weightings in your portfolio to "skew" it in your preferred direction.

Obviously, this process has certain costs and disadvantages. Specifically, the resulting portfolio is likely to be quite leveraged. It also won't be anywhere as liquid as "old-school" macro, although I personally don't think it's such a big deal.

So this is it, in a nutshell. Hope it helps.

Mod Note (Andy): Top comments - this comment was originally posted in the AMA "HF PM AMA"