The Prop Trader's Chronicles: Short-Term Proprietary Trading Strategies for Both Bull and Bear Markets

SURROGATE MARKET MAKING

The majority of non-bank proprietary trading firms are not registered market makers but often employ strategies that function in similar ways to those of a designated market maker in many ways. The advantage of this type of strategy is that it often allows a trader to participate extremely actively in the markets, which will, in turn, give the trader more bargaining power even if the trader chooses to use his or her own capital at a direct access brokerage. (Many direct access brokerages offer lower commission rates and pass-through ECN rebates for traders who are able to trade high volumes per month.) The disadvantage is that this sort of strategy only works if the commission rates are sufficiently low so that ECN rebates after commission charges can still net out to a positive value per trade. For many traders, a non-bank proprietary trading firm of the type that accepts risk deposits could be the perfect middle ground between a retail direct access brokerage and a full-blown proprietary trading model when it comes to fee structure for this type of strategy.

One of the most basic examples of a surrogate market maker's strategy is one that focuses on keeping a positive edge by earning rebates from ECN systems rather than constantly paying fees. While this naturally exposes the trader to adverse selection issues (for example, only getting orders filled when the market is ready to move against you rather than in your favor), many creative solutions are effective ...