Sifters and Drifters

Trading and market making (MM) strategies fall somewhere on a spectrum between what I refer to as sifters and drifters. Sifters are strategies that deploy liquidity at fixed price points such as the Fixed Limits.

Dumb Grid

Dumb Grid strategies (Episodes 4 and 5) as well as AMM pools and the 50-50 CPMM (Episode 15). These strategies allow the market to “flow through” them and extract a small profit as the market flows back and forth in price.

An analogy is that these strategies are like panning for gold, allowing most of the water and sediment (volume) to flow through them, but harvesting bits of gold (profit) along the way.

Drifters

Drifters, on the other hand, are strategies that follow the price action and are only executed when there are sharper swings up or down beyond the “average” price trend. The Spread strategy (Episode 3) as well as all of the Reference Market Maker (RMM) based strategies

(Episodes 11 and 12) are drifters as they use some proxy for spot price as a reference point for their orders.

The primary difference between sifters and drifters is that sifters prioritize assured gains (always selling higher than the purchase price) while drifters prioritize capital efficiency by keeping a significant portion of liquidity near the spot price. Another way to view them is by considering how they interact with arbitragers. Arbitragers can help sifters by executing their orders when the market somewhere else has moved the price past one of their grid lines. Drifters, however, constantly repost their orders in response to the market to prevent being arbitraged and could even be arbitrage strategies themselves.

My personal experience has been that, since sifter strategies are somewhat more disciplined in precisely where orders are posted, they are much easier to analyze and deploy as set-it-and-forget-it strategies. Drifter strategies are generally more complex and more difficult to predict how they would perform in any arbitrary market condition. This makes them generally more easy to be exploited by others who might know of edge cases that the person deploying might not have considered. As such, I see drifters more as strategies for targeted situations with a limited duration that should be more closely monitored.

Wrapping Up

The more automated you want to make a drifter strategy the more complex it becomes as you have to consider what sources of information you’re relying on and how it would react in any given situation. That said, drifter strategies have the potential to be very profitable as they tend to be more capital efficient. It’s also important to understand that not every strategy is distinctly a sifter or a drifter, they can have aspects of both.