Building a Nest
The Reference Market Maker (RMM) strategy covered in the last episode keeps orders a fair distance away from the spot price. The distance away from the spot that you place an order is something of a lever to decide how much risk you want your strategy to take. Perhaps a better way to word it is to say that it’s a lever on which type of risk you want to take. There is a risk associated with price moving well beyond your order (for smaller distances) and a risk that your order will seldomly or never execute (for larger distances), i.e. a type of opportunity cost. Sometimes, having a tighter spread earns you more as you’re executing more often even though the profit per trade is less.
Find Out
To address this conundrum, one good method is to take something of a shotgun approach, aka fuck around and find out. Now, there exists another strategy by the @axotrade team called the Percentage RMM that allows you to add an extra cushion to your spread, but we’re going to completely skip over this strategy. We’re degens and we want to trade in that opportunity cost for risk, so we are going to mosey on over to the Nested Reference Market Maker (NR MM) and the NR Spread x5 Type 2 (NR Spread).
These strategies are very similar and allow the user to create “nested” orders around the spot price. This is essentially like the last grid strategy configuration that was suggested in Episode 5, except the segments all move along with the price.
The NR MM takes the ref_mm! bid and ask, calculates the mid price between the two, and uses this as a proxy for the spot price. It then scales the spread that the standard RMM would give based upon the percentage specified. 100% produces the same bid/ask as the RMM, below this tightens the order spread, and above this increases the order spread proportionally. This is duplicated across 5 independent segments or “sectors” so that the user can specify different scaling percentages to create a series of nested sectors. Because the RMM strategy adjusts the bid/ask orders with volatility and other factors, the NR MM spread for each of the sectors will also change depending on market conditions.
The NR Spread strategy is nearly identical to the NR MM except that it maintains a constant order spread from the mid price. This makes it easier to understand what the strategy is doing (maintaining a specified spread) and is easier to analyze, but this comes at the cost of losing the dynamic adjustment that the RMM provides.
Remember that the standard RMM strategy (Episode 11) has roughly a 6% spread in “normal” market conditions. This means that a NR Spread sector with a 6% spread is roughly equal to a NR MM sector with a 100% scalar, a NR Spread sector with a 3% spread is roughly equal to a NR MM sector with a 50% scalar, etc.
Wrapping Up
By opening a number of nested positions, these strategies try to minimize both risk and opportunity cost as a portion of your liquidity is deployed with various spreads. This means that the strategy doesn’t go all-in on a set of parameters that may end up being sub-optimal. Another way to mitigate risk is by deploying less liquidity in your more risky sectors that have a tighter spread. This enables you to take advantage of some of the smaller orders that trade near the spot price, but doesn’t expose yourself to a large amount of inventory risk (IR) if there is drastic movement one direction or the other.
Finally, having 5 independent sectors within a single strategy is more convenient than creating 5 separate strategies, but it also makes it more difficult to analyze which sectors are over/under performing. It is always an option to use these strategies but only populate a single sector with assets if you’re more in the analysis phase of your MM journey.
