Question

In: Finance

If you are playing the ‘Price Formation” trading simulation and you have the right to trade...

  1. If you are playing the ‘Price Formation” trading simulation and you have the right to trade with limit orders but you do not have access to the private information signal, what is your optimal strategy? In particular:

    1. What should you do with your limit orders if buy and sell orders are coming in randomly?

    2. What should you do with your limit orders if you see 5 buy orders in a row?

    3. What should you do with your limit orders if you notice that you are accumulating a large short position in the shares?

Solutions

Expert Solution

In case of lack of access to private information an optimal strategy to trade with limit orders would be to trade as such that there would be less frequent price shocks in the market to the traders and the other participants of the market. By using the "Price formation" trading simulaton there should be creation of more efficient markets which would benefit the asset valuation industry to properly value their products neither being undervalued nor overvalued.

If buy and sell orders are coming randomly the first step would be see that whether there is any information in the market which has led to this situation and then accordingly a call needs to be taken for the limit order

If there are five buy orders in a row the limit orders should be modified in such a manner to create a profit structure during trading with the available information.

If a large short position is being accumulated in the shares then a subsequent buy order shall be applied to avoid any detrimental effect to the limit order

The answers is subjective as per the market information and trading situation. There are many other factors which would affect the above answer while trading.


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