Trading & Markets

Adverse Selection

The tendency to trade precisely with counterparties who know something you do not.

You only trade when someone chooses to trade with you - and they choose when your price is wrong. Conditional on being filled, your quote was more likely mispriced than not.

Getting filled is therefore evidence against your own price, not a success.

The auction form is the winner's curse: winning means you overestimated most, so rational bidders shade below their valuation.

The response is to widen or skew, not to trade more. A desk whose fills are consistently followed by adverse moves is being picked off.

Full guide

Adverse Selection: Why Getting Filled Is Bad News

The core hazard of market making. If your quote keeps getting hit, the market is telling you something.

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