Glossary
39 terms every market making participant should know.
Adverse Selection
The risk that a market maker trades with a counterparty who possesses superior information about imminent price movements. When informed traders consistently take your quotes just before the price moves against you, you are experiencing adverse selection.
A whale knows a token is about to be listed on a major exchange. They buy from your ask just before the price surges 5%. You sold at the old price and missed the move — that fill was adversely selected.
APY (Annual Percentage Yield)
The effective annualized return on an investment, accounting for the effect of compounding. In market making, APY represents the projected yearly return from spread capture and fee income relative to deployed capital.
A pool earns 0.05% daily from spread capture. Compounded over 365 days, the APY is roughly 20%, significantly higher than the simple 18.25% annual rate.
Arbitrage
The practice of exploiting price discrepancies for the same asset across different venues or instruments to earn a risk-free profit. Arbitrageurs help keep prices aligned across markets.
XRP trades at 1.350 on MEXC and 1.355 on Binance. An arbitrageur buys on MEXC and sells on Binance, pocketing the 0.005 difference minus fees.
Ask (Offer)
The lowest price at which a seller is willing to sell an asset. The ask is the price you pay when you want to buy immediately via a market order. Market makers continuously post ask prices above the mid price.
If the order book shows an ask of 1.3520 for XRP/USDT, you can buy XRP instantly at that price. The market maker who posted it profits if their average cost is below 1.3520.
Bid
The highest price at which a buyer is willing to purchase an asset. The bid is the price you receive when you want to sell immediately. Market makers post bid prices below the mid price to capture the spread.
A market maker quotes a bid of 1.3480 for XRP/USDT. When a seller hits this bid, the maker acquires inventory at 1.3480 and hopes to sell it at a higher ask later.
Book (Order Book)
A real-time, continuously updated list of all outstanding buy and sell limit orders for a trading pair on an exchange. The book reveals supply and demand at each price level and is the primary workspace for market makers.
The XRP/USDT order book on MEXC might show 5,000 XRP of bids between 1.3470-1.3480 and 3,000 XRP of asks between 1.3520-1.3530. The gap between the best bid and best ask is the spread.
CMF (Chaikin Money Flow)
A volume-weighted indicator that measures the accumulation or distribution of an asset over a specified period. Positive CMF suggests buying pressure; negative CMF suggests selling pressure. Market makers use it as one signal for inventory skew decisions.
CMF reads +0.15 over a 20-period window, suggesting sustained buying pressure. A market maker might slightly widen the ask or reduce ask size, anticipating continued upward price drift.
Delta-Neutral
A portfolio position with zero net directional exposure to price movements. Market makers strive to remain delta-neutral so their profit comes from spread capture, not from betting on price direction.
A maker holds 1,000 XRP (long delta). To become delta-neutral, they might sell XRP futures equivalent to 1,000 XRP, so a price drop that hurts the spot position is offset by gains on the short futures.
Drawdown
The peak-to-trough decline in portfolio value before a new high is reached. Drawdown measures the worst-case loss experienced during a specific period and is a critical risk metric for market making strategies.
A market making pool peaked at $10,500, then fell to $9,800 during a volatile session before recovering. The drawdown was $700, or 6.67%. Strategies aim to keep max drawdown below predefined thresholds.
Fill
The execution of an order — when a limit order is matched against an incoming order and the trade actually occurs. Fills are the core revenue events for market makers: each fill on a maker order earns a portion of the spread.
You placed a bid at 1.3480. A seller sends a market order that matches your bid — your order is filled. You now own XRP at 1.3480 and can post an ask at 1.3520 to complete the round trip.
Fill Rate
The percentage of posted orders that get executed within a given time window. High fill rates mean the market maker is quoting competitively; low fill rates mean quotes are too far from the market and rarely get hit.
Out of 200 orders posted in an hour, 140 were filled — a 70% fill rate. If spreads are widened for safety during volatile periods, fill rate typically drops because quotes are further from the action.
Gamma (Risk Aversion)
In the Avellaneda-Stoikov market making model, gamma is the risk aversion parameter that controls how aggressively the maker adjusts quotes based on inventory. Higher gamma means wider spreads and faster inventory mean-reversion; lower gamma means tighter quotes and more inventory risk tolerance.
With gamma = 0.5, the strategy slightly widens spreads when inventory deviates from target. Increasing gamma to 1.5 would cause much wider spreads and more aggressive skew to shed unwanted inventory quickly.
Imbalance
The asymmetry between buy and sell order volume at or near the top of the order book. Order book imbalance is a short-term signal: heavy bid-side imbalance often precedes upward price movement, and vice versa.
The best bid has 10,000 XRP stacked while the best ask has only 2,000 XRP. This 5:1 buy-side imbalance suggests short-term upward pressure, so a maker might skew quotes slightly higher.
Inventory Risk
The risk that a market maker accumulates a large directional position (too much or too little of the base asset) and suffers losses if the price moves against that position. Managing inventory risk is the central challenge of market making.
After a series of buy fills, a maker holds 500 XRP above the target. If XRP drops 2%, that excess inventory loses $13.50. The strategy mitigates this by skewing the ask price lower to encourage sells.
Kill Switch
An automated safety mechanism that immediately cancels all open orders and halts trading when predefined risk thresholds are breached. Kill switches protect against runaway losses from bugs, extreme volatility, or exchange anomalies.
The kill switch triggers when unrealized P&L drops below -$50 in a single minute or when latency exceeds 5 seconds. All orders are cancelled instantly and the engine enters a cooldown period before restarting.
Latency
The time delay between sending an order and it being acknowledged or executed by the exchange. Lower latency gives market makers a competitive edge — they can update quotes faster when prices change and reduce adverse selection.
A maker with 5ms latency to MEXC can cancel stale quotes before a price move hits them. A competitor with 200ms latency gets adversely selected because their old quotes sit exposed for longer.
Limit Order
An order to buy or sell at a specific price or better. Limit orders rest in the order book until matched and are the primary tool of market makers. On most exchanges, limit orders that provide liquidity (maker orders) receive lower fees or even rebates.
A market maker places a limit buy at 1.3480. The order sits in the book and only executes if someone is willing to sell at 1.3480 or lower. This patience earns the maker the spread.
Liquidity
The ease with which an asset can be bought or sold in size without significantly moving the price. Market makers are primary liquidity providers — by continuously posting bids and asks, they make it possible for others to trade instantly.
A liquid market has tight spreads and deep order books. XRP/USDT on MEXC might have $500K within 0.1% of mid — meaning you can trade $500K without moving the price more than 0.1%.
Maker
A trader whose limit order adds liquidity to the order book and rests there until someone else trades against it. Makers are rewarded with lower fees (or rebates) because they provide the liquidity that keeps markets functional.
You post a limit sell at 1.3520 and it sits in the book. When a buyer's market order matches it, you are the maker (you made the liquidity) and the buyer is the taker.
Market Depth
The cumulative volume of orders available at various price levels in the order book. Deep markets can absorb large orders with minimal price impact; shallow markets move significantly on even modest trades.
If there is 50,000 XRP of bids within 0.5% below mid, the market has good buy-side depth. A market sell of 10,000 XRP would only move the price slightly. In a shallow book, the same sell could cause a 2% drop.
Market Order
An order to buy or sell immediately at the best available price. Market orders execute instantly but pay the spread and potentially cause price impact if the size exceeds the liquidity at the top of the book.
You send a market buy for 1,000 XRP. It fills at the best ask (1.3520) and perhaps partly at the next level (1.3525) if the top of book had fewer than 1,000 XRP available.
Mean Reversion
The tendency of asset prices to return toward a historical average or fair value over time. Market making strategies often incorporate mean reversion signals — when the price drops below a moving average, the strategy bids more aggressively, expecting a bounce.
XRP's 5-minute average is 1.3500 but the spot price dipped to 1.3450. A mean reversion signal shifts quotes upward (bids become more aggressive) in anticipation that the price will revert toward 1.3500.
Mid Price
The arithmetic mean of the best bid and best ask price. The mid price represents the theoretical "fair" price of an asset at any moment and serves as the reference point around which market makers place their quotes.
Best bid is 1.3480, best ask is 1.3520. The mid price is (1.3480 + 1.3520) / 2 = 1.3500. The maker posts quotes symmetrically around this mid, adjusted for inventory and volatility.
NATR (Normalized Average True Range)
The Average True Range (ATR) expressed as a percentage of the current price. NATR normalizes volatility across different price levels, making it comparable across assets. It is a key input for adaptive spread calculation in market making.
XRP has an ATR of 0.0040 with a price of 1.3500, giving a NATR of 0.30%. The strategy uses this to set spread width: low NATR (calm market) = tight spreads; high NATR (volatile market) = wide spreads.
Order Book
See "Book." The electronic ledger maintained by an exchange that lists all outstanding limit orders organized by price level. The buy side (bids) is sorted highest-first; the sell side (asks) is sorted lowest-first.
A market maker monitors the order book in real-time via WebSocket feeds, watching for changes in top-of-book prices, depth shifts, and large orders appearing or disappearing.
P&L (Profit and Loss)
The net financial result of trading activity. Realized P&L comes from completed round-trip trades (buy then sell). Unrealized P&L reflects the mark-to-market value of open inventory. Total P&L is the sum of both.
A maker bought 15 XRP at 1.3480 and sold 15 XRP at 1.3520. Realized P&L = 15 x (1.3520 - 1.3480) = 0.06 USDT per round trip, minus exchange fees.
Price Discovery
The process by which markets determine the fair price of an asset through the interaction of buyers and sellers. Market makers contribute to price discovery by continuously adjusting their quotes in response to new information.
After a major news event, market makers widen spreads and adjust their mid-price estimates. As uncertainty resolves, quotes tighten and converge on a new consensus price — that process is price discovery.
Price Impact
The change in price caused by executing a trade, especially a large one. Price impact is a cost borne by takers — the bigger the order relative to available liquidity, the more the price moves against them.
Selling 50,000 XRP in a market with only 10,000 XRP of bids at each level would push the price down through multiple levels. The average execution price would be significantly worse than the initial best bid.
Realized Spread
The actual profit captured by a market maker on a round-trip trade, measured as the difference between the fill price and the subsequent mid price at a defined time horizon (e.g., 5 seconds later). It shows true maker profit after accounting for adverse selection.
You sell at 1.3520 (ask fill). Five seconds later, the mid price is 1.3510. Your realized spread is 1.3520 - 1.3510 = 0.0010, or about 0.74 bps. If the mid had moved to 1.3530, your realized spread would be negative.
Reservation Price
The market maker's internal estimate of fair value, adjusted for current inventory risk. In the Avellaneda-Stoikov model, the reservation price shifts below the mid price when the maker holds excess long inventory (encouraging sells) and above mid when short.
Mid price is 1.3500 and inventory is 200 XRP above target. With gamma = 0.5, the reservation price drops to roughly 1.3495, causing the bid to shift down and the ask to shift down — biasing toward selling.
Sigma (Volatility)
The statistical measure of price dispersion, typically expressed as the standard deviation of returns. In market making, sigma directly influences optimal spread width — higher volatility demands wider spreads to compensate for the increased risk of holding inventory.
XRP's hourly sigma is 0.3%. The Avellaneda-Stoikov formula uses sigma-squared in its spread calculation, so doubling volatility roughly quadruples the minimum theoretical spread.
Slippage
The difference between the expected price of a trade and the actual execution price. Slippage occurs when there is insufficient liquidity at the desired price level or when the market moves between order submission and execution.
You expect to buy at 1.3520 but the order fills at 1.3528 due to thin liquidity at the top of the book. That 0.0008 (0.06%) difference is slippage — a cost that market makers help reduce by providing depth.
Spread
The difference between the best ask and best bid price. The spread is the primary income source for market makers — they buy at the bid and sell at the ask, capturing the spread as profit on each round trip. Tighter spreads mean more competitive markets but smaller per-trade profits.
Best bid 1.3480, best ask 1.3520. Spread = 0.0040 USDT, or about 30 basis points. If a maker captures both sides, they earn 0.0040 per XRP on the round trip.
Taker
A trader whose order immediately matches against a resting limit order, removing liquidity from the order book. Takers pay higher fees than makers and bear the spread cost, but receive immediate execution.
A trader sends a market buy order that lifts the ask at 1.3520. They are the taker — they received instant execution but paid the spread (bought at 1.3520 rather than the mid of 1.3500).
Tick
In market making, a tick refers to a single cycle of the quoting engine — the periodic interval at which the strategy evaluates market conditions and refreshes its quotes. Also refers to the minimum price increment allowed by an exchange.
The engine runs on a 3-second tick: every 3 seconds it fetches the latest order book, recalculates optimal bid/ask quotes, cancels stale orders, and posts fresh ones.
Turnover
The total volume of trades executed over a period, often expressed as a multiple of deployed capital. High turnover with small per-trade margins is the hallmark of market making — profits accumulate through volume, not large individual gains.
A pool with $10,000 capital trades $50,000 in volume per day — that is 5x daily turnover. At a 3 bps average spread capture, daily revenue is $50,000 x 0.0003 = $15.
Volatility
The degree of price variation over time, commonly measured by standard deviation of returns or ATR. Volatility is both opportunity and risk for market makers: higher volatility allows wider spreads (more profit per trade) but increases inventory risk.
During a calm session, XRP volatility is 0.2% hourly, and spreads are tight. When volatility spikes to 1.5% after a news event, the strategy automatically widens spreads from 0.004 to 0.012 USDT.
VWAP (Volume-Weighted Average Price)
The average price of an asset weighted by trading volume over a specific period. VWAP is used as a benchmark to evaluate execution quality — buying below VWAP or selling above VWAP indicates favorable execution.
Over one hour, 100,000 XRP traded with a VWAP of 1.3510. If a market maker's average buy price was 1.3495 (below VWAP) and average sell was 1.3525 (above VWAP), they outperformed the benchmark.