1. Davin Appanah is a Quant/Trader specialised
on Interest Rate Derivatives and hedge fund
systematic strategies. He studied in Paris and
worked in the asset management/Investment
banking industry for more than 10 years in Eu-
rope and the US.
Is 1599 a prime number?* by
Davin Appanah
InternationalAnalyse
Writing notes is not only a quest to share ideas but
also to learn new things through interaction with oth-
ers. Financial markets are becoming more complex
each day, some say its rigged others proclaim that
technological innovation will completely take over
human intervention in certain segments of the indus-
try. New avenues to rethink currencies or to redefine
the role of banks are debated everyday. Mauritius,
due to its island characteristics, is often remote from
major changes in the financial world. Bearing in
mind, the weight of government, bureaucracy and the
political matter, I am pretty pessimistic when it comes
to the reforms which authorities are trying to imple-
ment. Make no mistake, engaging heavy spending
on infrastructures is important but as usual, politics
and ancillary considerations often take over the core
substance of these reforms. Unfortunately, the model
which will be working in the coming years is an hori-
zontal one not a vertical structure which Mauritius
is still promoting. But above all, having flexible and
light structures will be of utmost importance. Albeit a
small country, Mauritius is an ostentatiously costly/
heavy, barely an efficient economy.
Mauritius has a scantily stock or fixed income mar-
ket. To develop a relevant
financial market, there
need to be venues where
people can raise, invest
capital and hedge these
investments. Additional-
ly, it is vital to have the
right infrastructure, a well
trained human capital and
the suited financial instru-
ments. All this should be
under the rule of law and
strong independent institu-
High frequency
trading and market mak-
ing activities are impor-
tant drivers in a sophisti-
cated economy”
tions with top notch oversight.
High frequency trading and market making activities
are important drivers in a sophisticated economy.
This little note will explain a high frequency strategy
which helps price discovery. Financial markets oper-
ate in a quote driven process where few market mak-
ers would provide the only liquidity and prices of fi-
nancial assets. They will try to buy cheap and sell the
highest possible. They will have an inventory control
and will make sure that peo-
ple buying or selling don’t
have better information
than them. There are vari-
ous techniques to identify
private information from the
potential buyers or sellers.
Nowadays, these techniques
are completely automatic or
computer driven. Speed is
important, execution capaci-
ties also and usually holding
periods are on a very short period. With the advent of
these innovations, a higher accuracy, lower costs have
poured new participants into the market and thus
enhancing liquidity. Temporary market inefficiencies
or price discrepancies are the main entry signals for
these high speed traders.
VINKERS PERSONAL FINANCE MAGAZINE Novembre 2016 27
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2. As a matter of fact, when-
ever you are engaging the mar-
kets, just your action has an
impact on markets, most of the
time its a negative impact”
Limit order books allow traders to become market
makers in the financial markets. Its a mechanism
where traders can submit limit buy (sell) orders for an
asset and the prices they would like to pay ( receive).
The limit order book is a complex matrix and the
agents who can analyse it properly can retrieve signif-
icant insight from the market intentions. This can help
in the development of trading strategies, with the use
of very rich granular data obtained from this matrix.
So, the limit order book acts like a matching engine
for buyers and sellers in the market. The best bid(ask)
price is the highest(lowest) price a market maker is
willing to buy(sell) the asset at to market takers. The
maximum number of contracts that the market makers
are willing to buy( sell) at the bid(ask) price is called
the best bid(ask) volume. The market taker who wish-
es to buy or sell at the counterparty price is the market
order. He can submit a market order to trade at the
best ask(bid) price up to the ask(bid) volume avail-
able. If the market order to buy(sell) is larger than
ask(sell) volume, he
is said to be walking
the book, meaning he
will continue buy-
ing(selling) at the
next best ask(bid)
price until the entire
market order is filled.
To analyse, these
data, high frequen-
cy traders often use
stationary processes,
which means that
considering this to be
a stochastic process where joint probability distribu-
tion don’t change with time. In simple words, mean,
variance, autocorrelation must be constant over time.
We do distinguish between strong stationarity and
weaker ones. Methods to test stationarity are Aug-
mented Dickey Fuller Test, KPSS, Philipps Perron
. Strong stationarity is difficult to identify. Weak
stationarity can suffice for devising a high frequency
trading strategy.
Studies have shown that there can be a relationship
between trade activity(volume) and price change
and volatility. As a matter of fact, whenever you are
engaging the markets, just your action has an impact
on markets, most of the time its a negative impact.
For example, if you want to engage markets with Q
contracts, you would expect that your price will be
affected by a Q factor with time. Statistics measures
showed that in fact your price will be degraded not
by a factor Q but by SQRT(Q). So, as traders submit
limit orders to buy or sell, they impact the bid and ask
volumes of the limit order book. This manifestation of
behaviour will show an activity where intentions can
be located. So categorizing trade volume as either par-
ticipants taking bid(ask) would allow to gain insights
into the direction of the upcoming price changes. To
be able to analyse this phenomenon, we need to look
at the differences between bid and ask volumes called
the order imbalance. Studies showed that there is a
positive correlation between these imbalances and the
daily returns on stocks or some highly liquid bonds.
So, this technique is helpful to grasp the general
sentiment and the trend of the market. This can be
exploited in 2 ways, informed traders who have pri-
vate information about the stock which are not in the
prices, can capitalise by a long or short trade depend-
ing on the direction the market is taking. Secondly, by
just analysing the phenomenon, a trading strategy can
be devised.
In order to build
this strategy, con-
sideration must be
taken on current bid
prices and previous
bid prices( a lag
before), same thing
for asks. This will
help in determining
the intent of traders.
For example, if Pre-
vious BID price is
greater than current
BID price, we can
imply that either the trader cancelled his limit order or
trade was filled at previous Bid Price. Due to the un-
certainties here, the Change in Volume Bid is flagged
as zero. This is one of the 3 examples categorising
the price behaviour in order to determine the intent of
the trader. By cornering all these behaviours, we will
be able to take positions in a more systematic way
and analyse these statistically. It is also important to
check auto-correlation of the imbalances as it adopts
the same behaviour as volatility where high prolonged
period of volatility are followed by low prolonged
period of vol.
* : Interview Question for Investment Banking ( to be
answered in less than 20 seconds) : 1599 = (1600-1) =
(40^(2)-1^(2)) = 39 * 41 = Not Prime Number.
428 VINKERS PERSONAL FINANCE MAGAZINE Novembre 2016
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