Market Making: Why Trade Flow Matters

If you are a market maker, you might notice that on some markets it is much more difficult for an ask order to get filled than a bid order. If you have ever wondered why this happens, trade flow is a good metric to pay attention to.

Trade flow is the quantity that is bought minus the quantity that is sold by takers. If trade flow is positive over a day, takers are buying more than they are selling and the reverse if trade flow is negative. As a market maker, this might be an important number for you.

On occasion, if you find that the trade flow is overwhelmingly negative, getting an ask order filled might be difficult and getting a bid order filled would be easy because more asks than bids are getting taken. For example, on November 3rd, Bitcoin on the Binance linear perpetual market had a trade flow of -8672.068 BTC. That means takers sold 8672.068 more BTC than they bought that day.

What should trade flows look like?

My expectation was that, when prices rise, trade flows should be positive. When there is positive flow, there is more buying than selling, which means people are forcing the price up as they aggressively buy, and they would benefit from the rising prices by simply holding on to their long position.

I decided to test this out by looking at the trade flows of all coins on the Binance linear swap market. To compare markets, I created normalized trade flow by dividing trade flow by the total volume of the market in the same time period. Here’s a histogram of the results from November 3rd:

This is a little weird, right? Every single coin had a negative trade flow that day. It surely can’t be a coincidence. The trade flow across the entire linear market is -4.187%. Maybe the market as a whole was down that day? If prices were falling across the board, you would certainly expect people to be selling more.

Well, ETH and BTC certainly didn’t have the best day. It’s possible that the negative flows can be explained by the fact that the markets were going down. However, here’s an example of a coin where the price was going up but the trade flow was still negative.

ATOM’s normalized trade flow was -7.987% that day. Despite ATOM’s price rising, the amount of ATOM takers sold was 8% more than the amount they bought. This is definitely a peculiar phenomenon, but maybe this was just a weird day in the market. Instead, let’s look at a day when ETH and BTC prices were going up steadily, October 13th:

The prices consistently increase throughout the day. If prices are going up on these two, it’s usually safe to assume that prices are increasing across most other coins. But look at the trade flows.

Still mostly negative, but higher than they were on November 3rd. Across the market, trade flow was about -0.817%, much higher than the -4.187% on November 3rd. There are four coins that are positive.

In ascending order of normalized trade flow, they are THETA (0.211 %), ONT (1.574 %), WAVES (1.831 %), and BTC (1.915 %). Prices were increasing significantly across all these coins. Maybe these are coins that have trade flow which better aligns with price movement?

Meanwhile, ETH on the other hand was sitting at -1.393%, which is on the higher end of the 128 coins with negative trade flow. Any day I look at, trade flows are overwhelming negative for that day. How negative can these get? What happens on a day when the market is moving down? How about September 19th?

Haha! Across the market trade flow is in the depths at -5.506%. You are going to have to fight to get passive ask fills on a day like this.

So, on the Binance linear perpetual market, takers are selling more than they are buying fairly consistently across all coins.

Why is this happening?

One guess is that this is the market where traders like to hedge any bitcoin they have, which makes sense! If you want to have bitcoin but not be exposed to price changes, you would sell in a perpetual market.

It also makes sense from a funding perspective. Funding rates are mostly positive. People passively buy on the spot market at a price where they can make enough money from funding by selling into the perpetual market. If something like this were happening, there should be no one direction trade flow, positive or negative, since they are all passive. Here’s the spot market’s trade flow on Nov 3rd.

The trade flow is much closer to zero here! Across the spot market, it is about -0.399%. I suspect it’s slightly negative because the markets were going down that day but it’s definitely much higher than the whopping -4.187% on the linear perpetual market, so the hedging theory holds some weight.

Understanding trade flows is key to improving market making ability on specific markets. With the overwhelmingly negative trade flows on the Binance linear perpetual market, asks will need to be priced more aggressively than bids to get hit. So, next time you find yourself having trouble getting an order to hit, consider which way the trades are flowing.

-Noah, Trading at Dexterity Capital