I'm interested in learning about algorithmic trading, particularly in bitcoin.
Looking at this chart, I can see that I could simultaneously offer a bid that was slightly higher than the highest bid, and an ask that was slightly lower than the current lowest ask.
Whenever anyone bought or sold, that would mean that I would always be one of the people they bought/sold from/to. This would allow me to make a profit equal to the gap between the two.
The problem I'm having is in calculating the risks. As far as I can tell the variables involved are:
Variables out of my control
- Gap between highest bid and ask offered by others
- Average price paid for "pot" of BTC that I'm trading with
- Some measure of the volatility of prices over the preceding period (Risk)
- How much volume would move the market by a given amount higher or lower
Variables within my control
- Maximum exposure in terms of money
- Maximum difference in ratio between GBP reserve and BTC reserve
- Size of the gap between my bid/ask prices (out from the exact centre as percentage of total gap)
I'm struggling to figure out how to model this effectively though. I studied Computer Science and have a basic grasp of probability theory, but this is a bit beyond me. Any help, or pointers to the "proper" formula to model this would be greatly appreciated.
Get your hands on some books on economics, econometrics, and financial engineering. Take a few years to understand them, and then model the bitcoin economy in terms of:
Speculation will dry up sooner or later, and we'll finally be left with a stable currency for doing business.
Also, your approach to modelling isn't so hot. Using variance of price as a metric of risk works okay in massive markets. Not so much in these tiny, highly volatile, shark infested markets.
As a limiting case, consider a market with exactly two participants. The model here is "negotiation", which is very different from the model for a large open market.
The point is: an effective model has to be driven by the economic considerations.