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It is difficult to grasp the immensity of the arbitrage system. Yet, it seems to remain in the shadows with little information or even interest in it.
Let's take NASDAQ for example.
If you trade the future version of the nasdaq 100... you have a very strong correlation to other stock index futures. If you display charts on a 1-second time frame with only the closes of the 4 major indexes, it is amazing to notice that most of the time, all the indexes move in unison tick by tick.
But that's not all... there are other derivatives, such as the ETFS (TQQQ) and even inverse ETFS.
And if that is not enough, you have most of the stocks of all the indexes... that have a weaker correlation than the other indexes, but still are very correlated.
The amount of power to keep all this world correlated defies common sense.
Imagine a very large player pouring a ton of money on the NQ.... no matter his size, he will not be able to significantly deviate the NQ that MUST stay correlated to other instruments by a colossal force that is able to reduce any influx strength in order to keep the correlation.
I just can't grasp what colossal force is responsible for this arbitrage. Who are they? Where do they get their funds from?
Do we have books or videos about arbitragers and how they operate?
How come there is so little info disseminated about it. Most people trading don't have a clue about how this whole system operates.
There are different types of arbitrage. But I assume that you have already looked at this in advance. Following are some ideas to your question which might interest you:
The thing is that arbitrage is taking advantage of momentary differences in pricing of things that should be equivalent. So when ES drifts a little away from the pricing of a representative basket of stocks that are pretty close to the S&P, it's free and easy money. The arbs buy whichever is lower, sell whichever higher. If the difference gets larger, they do more. The prices come back together due to the buying/selling. Profit ensues.
The markets are not in step from the application of an enormous and unknown force. Markets that are similar are kept in synch all the time because if they get out of synch, they are mispriced and someone is going to quickly make a few bucks and help them move back together.
Bob.
When one door closes, another opens.
-- Cervantes, Don Quixote
Well, I assume you aren't asking me for the names of the firms that specialize in arbitrage (if you are, I have no idea.)
The thing about arbitrage is that there is an opportunity for essentially risk-free profit if you can buy something in one market and simultaneously sell its equivalent in another market, at a higher sale price than your buying price. Given that, the only things that are needed for a firm to simply clean up are (1) a significant enough price difference to cover their costs with something left over, (2) the ability to move fast, (3) reasonably deep pockets.
How deep? Well, not some enormous amount of "force," because all that it takes to profit from the difference is to be able to recognize it and take positions on both sides. If there are enough players in the game, then their combined action will erase the price difference -- which also limits the opportunity, which is why this is not exactly a gold mine for everyone. Market competition will keep the successful arbs limited. But it's a natural aspect of the markets. Anyone who can manage those three things can play.
So basically, I'm saying it is not something that requires someone having "enough force" to do something extraordinary. There is arbitrage in every market and between every market when the conditions exist for it, and there always is. It is really not a huge deal.
The obvious arb opportunity in futures is between the stocks in an index and a futures contract on that index. Since the futures will be settled in cash depending on the final prices of both, the futures market could not serve as a hedge against a stock holding if the prices were not held pretty well in step. Arbitrage is what does this.
If this doesn't satisfy you, then I guess I can't, because it's what I've got.
nothing mysterious about arbitrage. Arbitrage is what is happening every micro second in every open mkt around the world.
True arbitrage is riskless or virtually riskless which is exactly why hft firms use it predominantly and have pricing and never ending margin amounts that allow them to
constantly add and subtract contracts and shares based on the liquidity needs of their execution customers and the companies personal inventory.
I would not any recommend that any muse clicking retail fee/commission level trader ever try and attempt to recreate an arb. it is just not possible in todays environment with HFT and colocation and the
amount of margin large hft firms to the tune of billions and billions.
Yes it is nice to understand who the hell is selling right now or who the hell is buyig right now and it also answers the question of how can there be a seller for every buyer etc?
We are talking about companies and trading firms that arb micro baskets of sp500 stocks against the sp500 futs etc. and it is global i.e. at night they will arb usa europe japan china australia all in baskets against whatever their mathematicins and algos have decided will have some kind of short term relationship over the next few seconds minutes or days.
When an arb doesnt work you can plow more money at it at better prices hoping to get back to even or a slight gain but if it blows up on you then you can lose a lot.
The only reason arb is riskless is due to the fact that hft and other arb firms are constantly arbing multiple markets. they are diversifying an already almost riskless trade but the
probabilities are on their side in the law of large numbers. this is why citadel and virt can go years without a losing day. it is cumulative of all trades in all global markets for the day.
To give you a quick example. the ES trades in 12.50 increments and the nasdaq trades in 5 dollar increments.
trick question how do you get a trade where the es trades in $ 2.50 increments?
well 3 es per tick is 12.50 x3= 37.50 and 8 nq is 5x8 = 40 so you get 40-37.50 = $ 2.50 increment.
no way you can try to do this without hi speed colocation and ultra low fees.. this is also why citadel may only make 3 cents a futures contract overall by the end of the day but this also
explains why citadel is a liquidity provider because they are bidding and asking 11 contracts to maybe make $ 2.50 yes 2 dollars and 50 cents but look at all that liquidity!! they are a liquidity provider now multiply that by millions of contracts a day globally and you making some serious risk free money.,
Yes there is way more too it as far as being successful with it but speed matters almost more than anything because the TRUE ArB HAPPENS in between the seconds on your chart.
when it appears you ahve 30 hft firms computers all trying to exit and enter at the same time like a feeding frenzy. now do they miss arbs and get pissed off and smash the markets hoping to HANG UP or smash a smaller less capitalized HFT by buying say a ton of tesla to push teh sp500 yup you bet they do.. all legal.
anyway it is great to understand it but please save yourself the time and energy and move on to working on your discipline not worryng about what the algos are doing to make money. yes they are always fighting us.
Lastly if you saw the markets like the hft arb machines do then all you would see is a straight line horizontally in almost all time frames with the smallest amount of range you could ever imagine. this is what they trade. you don't need to believe me but it is the truth.
Good luck with your trading or studying
here is an example of what the arb machines see as far as the markets are concerned.
here is an hft arb chart say in the microsecond realm and this all of the markets they trade combines into 1 enormous glorious chart ok.. yes every single one china usa autralia crypto stocks options whtie noise technicals fudnalentsls etc. all of it is in there.. drum roll....
__________|_______|_____||||_______ those little blips up are sold into to bring all of the markets back into the straight line. understand? it is truly that small but the law of large numbers and lots of other scientific formulas that have been around since the late 1800's say it works and it does but it only works when you have teams of data scientists and temas of high speed colocations aroudn the world.
wikipedia law of large numbers that is what the hft are doing. basically every trade is a randomized dice roll but x millions over time and you get white noise.
this also EXPLAINS how the more RANDOM SOMETHING LOOKS the more manipulated it truly is in the markets.. i.e. randomness over time with enough rolls or tests or trades is no longer random in micro time slots or buckets.
Part of a series on statistics
Probability theory Standard deviation diagram micro.svg
Probability AxiomsDeterminism SystemIndeterminismRandomness
Probability spaceSample spaceEvent Collectively exhaustive eventsElementary eventMutual exclusivityOutcomeSingletonExperiment Bernoulli trialProbability distribution Bernoulli distributionBinomial distributionNormal distributionProbability measureRandom variable Bernoulli processContinuous or discreteExpected valueMarkov chainObserved valueRandom walkStochastic process
Complementary eventJoint probabilityMarginal probabilityConditional probability
IndependenceConditional independenceLaw of total probabilityLaw of large numbersBayes' theoremBoole's inequality
Venn diagramTree diagram
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Thanks for your answers guys.
I do understand roughly how arbitrage works. But understanding this doesn't make it less incredible.
I mentioned a "force"... well nothing esoteric of course. But the amount of liquidity to enforce real-time arbitrage correlation between ALL stock indexes derivatives and stocks is phenomenal. Is it even possible to derail an instrument from its arbitrated course with enough buying or selling thrown at it? I would say that nowadays it seems almost impossible.
HiLatencyTRDR I can see all the HFT arb firms working on this. There is no central authority that decides what must be correlated with what... it just happens. Like gravity is holding our planets together. They have no independent course.
Also about stock indexes and their components: sure they are arbitraged to move in unison but is their global direction also arbitraged?
If S&P500 goes up strongly (and with it all its stocks and derivatives).... is this global move also the result of arbitrage, maybe against the Bonds? Is there a single instrument in this global market that is not HFTed arbitraged against another instrument and purely the result of old-school speculation?
Another observation raised by the mention of HFTs: When you display a 1-second chart of the NQ or even ES with number of trades (not volume).... the numbers are not what one would expect from hundreds of HFT firms executing millions of trades per day or even milliseconds even if they are spread across various instruments. What you have is a few dozens of trades per second... nothing "inhuman"... even less than one would expect from 1000 retail traders trading the same instrument. Another strangeness I have a hard time explaining that even contradicts my point in this thread.
lets see what you see is not a real feed sure it is best you can get as a retail guy but it is not real as far as trades etc. so much of what YOU and I see is latent the fastest "INDICATOR" is you rlatent price chart. the price chart in real time for any at home or phone traders is actually a moving average of the markets 50 micro seconds to 100 microseconds after it already happened. but do not look at the voluems or trades and anticipate that there is any real ness to it yes at the cme you have centralized ex change sure but come on many trades are busted and even mroe are in the form of "look a like contracts" in the otc market.... google it.
everything and anyting that can be arbed or games is arbed or gamed to the fastest and the smartest. it is all one big eco system.
I have done over 1100 lots in less than 3 minutes to see how my market order fills would get filled and it was pure randomness.. i was up 10k on and tehn by the time i was flat
i made about 2200 on the 3 minute flurry of my mkt order trades. my biggest lot was 230 micros near the end when i was closing out. sure i should have closed out when up 10k but
there was an error of course human .. me on my exiting and understanding exactly where i was at on the trade because it all happend so fast. i just kept adding and adding and subtracting. the machine couldnt keep up with my trades.. that is my machine and 4 seconds later and 8 grand vaporized. sure was a rush though.. i dont recommend this
p.s. there are not nearly as many people trading futures as you would think. to be anonymous in futures is nothing like stocks. seriously even in the ES500 there are only what 2 million traded on a huge day in volume. that is super small volume compred to stocks where you can be a little more anonymous. if hft is filling 75 % of all trades then they know they are filling you!! then they come get you..bahahah then they go back to get you gain
