Your bid keeps getting hit and inventory is piling up

Question

You quote a two-sided market. Over the last while, sellers keep hitting your bid while your offer rarely gets lifted, and your inventory is growing long.

What does this one-sided flow tell you, and how should you adjust your quotes?

Accepted Answer

One-sided flow is a signal, not just bad luck. If far more people want to sell to you than buy from you, the market's supply and demand at your current price are imbalanced: your bid is probably too high relative to where value is heading. Some of that selling may be informed, sellers who think the asset is worth less than your bid, so you are being adversely selected on the buy side. You are accumulating inventory at prices that are, on average, above where the market is going. Two problems stack up: 1. Adverse selection: the fills themselves are tilted toward informed sellers. 2. Inventory …

Your bid keeps getting hit and inventory is piling up

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