Mega Profitable Edges That Have Gone

Looking at The Exchange Arbitrage and Rebate Trader Edges

Trading Edges That Have Gone

Last week I made a post about my brief experience visiting a Vegas prop firm. And it got me thinking.

What trading edges have been and gone over the years? 

What strategy used to be very lucrative and has now disappeared?

Either through technology stealing the trade or a general change in market conditions.

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#1 The Exchange Arb

This was a really old strategy. Way before my time…

Traders used to place trades in the trading pit. The days of signalling via hand to another trader or broker and writing down the subsequent trade on a ticket.

In some places, instruments would trade on two different exchanges located in different places geographically.

One example of this was the Nikkei.

The same contract traded on both SIMEX and OSE.

But as this was open outcry they often traded at different prices. No computers to automatically arb off the prices. A savvy trader could have two order clerks manning the phones, traders in each pit and arb off the price difference.

Eg: If SIMEX was trading at 2000 and OSE was trading at 2025 you’d instruct your SIMEX trader to buy at 2000 and your OSE trader to sell at 2025. Banking an immediate profit.

(In fact, I believe that Nick Lesson was doing this before he went rogue.)

Sam Bankman-Fried actually did this arb in Bitcoin during it’s early days. (Until he committed huge fraud at FTX that is…)

#2 Rebate Trader

When electronic trading was just taking off, several ECNs were trying to become the primary place to route your stock orders and would offer chunky rebates for adding liquidity.

This is how it works:

If you wanted to buy say 10,000 shares of IBM you could route the order through the specialist, market maker, or an ECN. ECN (Electronic Communications Network) is basically a virtual liquidity exchange. The idea was that orders would match instantly on these rather than taking some time through a market maker.

ECNs would incentivise adding liquidity to the order book.

IE: If you entered a limit buy order under the bid or a limit sell order above the offer that was providing liquidity.

Removing liquidity meant buying at the market, or taking shares available on the order book. As they wanted you to add liquidity not remove it, they would charge you for liquidity removal and pay you for providing liquidity.

This spawned a whole world of trading just for rebates.

Traders would not be looking to make money from direction, they just wanted to provide liquidity and get paid for it.

For this, you needed two things:

  1. A stock that barely moved
  2. A large bankroll
  3. Rock bottom commissions

You could easily get 2 and 3 with a prop firm.

1 – Was stock selection.

Some stocks would move a cent or two during the whole day.

So traders would stack orders on an ECN offering a high rebate and simply wait to get filled.

They’d aim to scratch off the trade at break even or make a penny.

But as long as they were adding liquidity to both sides they make money on the deal.

(ECNs still offer rebates which influence how stock traders route orders but I don’t know of any traders still deploying this strategy as a pure rebate play method.)

I can think of a bunch more edges that have long gone, but perhaps I’ll save those for another post. These are meant to be 3-minute reads not essays!