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Topic 2

Topic 2. Introduction to Trading Simulation. Purpose. 1) Experience what trading involves Tactical, fast decision making Be a prop trader, buyside equity trader, market maker 2) Participate in a process that translates news into prices

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Topic 2

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  1. Topic 2 Introduction to Trading Simulation

  2. Purpose 1) Experience what trading involves • Tactical, fast decision making • Be a prop trader, buyside equity trader, market maker 2) Participate in a process that translates news into prices 3) Evaluate the effects of trading rules and alternative market structures on: • Investor participants (the naturals) • Market maker intermediaries • Market quality 4) Compare and understand alternative market structures 5) Compete and have Fun

  3. An Important Distinction Simulations can be based on either 1. "Canned" data from past events 2. Computer-generated data TraderEx is based on computer-generated orders and price changes – not canned repeats of past events

  4. A Trading Simulation Requires • Prices can be affected by your actions • You have some basis for anticipating future price changes • Prices can move in harmony with news releases • Prices do not follow random walks • Simulation runs can be replayed • Your performance can be assessed

  5. Performance Assessment • Performance characteristics • Profit and loss (P&L) • Beat Volume Weighted Average Price (VWAP) • Control risk (avoid large inventory positions) • Get the job done (execute your orders, liquidate your positions) • Your Score • Weighted combination of the above

  6. What Drives Trading? Machine generated order flow is based on draws from various statistical distributions. We can view the statistical events as representing solid economic stories. • New information (news) • Liquidity motives • Technical (noise) trading • Divergent expectations (people disagree with each other) Economic stories concerning the motives for trading

  7. Liquidity Order Flow Informed Technical Trading P* Is there a trend/ pattern? Quotes, Prices, Volume Is p*>offer or p*<bid? Orders Come from 3 Types of Traders Do the informed Traders agree with each other? maybe not! Trading Mechanism

  8. Ask Ask Bid Bid Sells Buys The Economic Story Behind the Consensus Price, P* P*

  9. A Typical Random Walk Pattern Of P* P* Day 1 Day 2

  10. P* and Best Bid and Offer Quotes P* Ask Bid Day 1 Day 2

  11. P* and News • In simulations P* need not change according to random draws from a distribution • When united with news release, new P* values are set in accordance with the news

  12. Distribution For Generation of Liquidity Motivated Sell Orders 26.60 26.50 Limit sell orders Price (5¢ Tick Size) 26.40 26.30 26.20 Offer 26.10 Bid 26.00 25.90 Executable sell orders 25.80 0% 2% 4% 6% 8% 10% 12% 14% Probability

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