Trading Simulation Strategies in Interview Questions
What were they looking for in these interview questions regarding strategies for trading simulations?
The situation:
We have some asset who's value is randomly distributed over the range [0,100].
An 'informed trader' is someone who is given a 20-length range containing the true value.
EG [15.5, 35.5].
The other traders, 'liquidity traders', have some trading target (EG you must SELL 20 shares).
The informed traders' profits are calculated against the true value.
Liquidity traders' profits are calculated against the VWAP (volume weighted average price). IE their P/L for BUY transactions is volume*(VWAP - tradePrice). And of course we only know VWAP at the end, which is the average price at which the asset traded for over the course of the simulation.
Assume there is around 20 people in the simulation.
First Scenario:
There is 1 informed trader.
How will you approach this simulation if you are: the informed trader OR you are one of the liquidity traders?
Second Scenario:
There are 3 informed traders.
My thoughts:
Obviously if you are the informed trader in situation 1 then you will trade on all bids which are higher than your upper bound and all asks which are below your lower bound.
A good strategy for the informed trader would be to do this until the very end, and then the liquidity traders who have not completed their trading obligations near the end will be forced to trade at the spread you put out, which would be the upper and lower bounds of your confidence interval.
Important to note that the spread will converge to the informed traders' confidence interval (or however he decides to trade within it) because he will move the price within those bounds.
If you are a liquidity trader in situation 1, you can only make money by trading better than the other uninformed traders. You can do this by:
- Taking a risk at the start, and putting out some large spread, say 20@80, and hope that someone trades with you and that the true value is within this range.
- Putting out a false spread, say 30@40, with a large volume on the bid, and a volume of 1 on the ask, to make it appear as though the informed trader has put out his spread, and hope that many people sell at your bid price. This is only successful if the true value is above 30, and if you can make up for the money you lose on the 'dummy' ask with trades on the bid.
- Wait until the end, and pick-off trades of people desperate to make their trade target obligations.
