Market Microstructure & Trading Strats
Szymon Kopyciński · 23 September 2026
1. Market microstructure
Market microstructure
The study of how trading mechanisms affect prices, liquidity, execution and behaviour.
It deals with questions such as:
- How are orders matched?
- How does information enter prices?
- Why do spreads exist?
- What determines queue position?
- How does order flow affect short-term price movement?
It draws on economics, statistics, trading and engineering.
Order flow
The stream of buying and selling activity entering a market.
Traders study whether order flow predicts short-term price movement.
Order book imbalance
A measure comparing displayed liquidity on the bid and ask sides of the book.
A simple version is:
$$ I = \frac{B - A}{B + A} $$
where $B$ is bid quantity and $A$ is ask quantity.
Positive imbalance means more displayed bid quantity; negative imbalance means more displayed ask quantity.
Adverse selection
The risk that someone trading against you has better information than you do.
Suppose you continuously offer to sell at £100.01. If informed traders disproportionately buy from you just before the market rises to £100.10, your fills are systematically poor. This is adverse selection.
Toxic flow
Informal term for order flow that tends to be particularly adverse to a liquidity provider.
Informed trader
A trader whose actions contain information about future prices or market conditions.
This does not imply illegal inside information: they may simply have a better model, faster data or a better interpretation of public information.
Price discovery
The process through which trading causes information to become reflected in market prices.
Fragmentation
The splitting of liquidity across multiple venues.
Traders may need to combine data from several venues to see the whole market.
2. Trading styles and strategies
Strategy
A defined method for deciding when and how to trade.
A quantitative strategy expresses those decisions through explicit rules or models.
Systematic trading
Trading according to predefined rules or models, usually implemented in software.
Discretionary trading
Trading where a human trader exercises judgement in making decisions.
Many approaches combine elements of both systematic and discretionary trading.
Signal
A piece of information used to predict something relevant to trading.
A signal might predict:
- future return;
- volatility;
- order flow;
- liquidity;
- relative value;
- another market property.
Alpha
Return generated by information or skill rather than by taking broad market risk.
In practice, alpha is often used to mean any predictive edge or profitable signal.
Edge
Any persistent advantage that produces positive expected value.
An edge might come from:
- better modelling;
- better execution;
- lower costs;
- faster systems;
- better data;
- superior risk management;
- market structure.
Market making
Continuously quoting both buy and sell prices with the aim of earning the spread while managing inventory and adverse-selection risk.
A market maker might quote:
BUY 99.98
SELL 100.02
and aim to trade on both sides.
Arbitrage
Profiting from inconsistent prices for economically equivalent or closely related assets.
True risk-free arbitrage is rare and short-lived. The word is also used more broadly for relative-value strategies.
Statistical arbitrage / Stat arb
A broad family of systematic strategies that exploit statistical relationships between securities.
Despite the name, these strategies carry real risk.
Pairs trading
A strategy involving two historically or economically related instruments.
A trader aims to profit when their relationship deviates from its normal level and then reverts.
Mean reversion
The tendency of a variable that moves away from its typical level to move back towards it.
Mean-reversion strategies aim to profit from temporary price dislocations.
Momentum
The tendency for assets that have recently moved in one direction to continue moving in that direction over some horizon.
Trend following
Trading based on sustained price trends.
Trend-following strategies buy rising markets and sell or short falling markets according to predefined rules.
Carry
Return earned from holding a position, separate from any change in its price, such as dividends, coupons, interest-rate differentials or futures roll yield.
The exact meaning differs between asset classes.
Basis
The difference between two related prices.
The most common example is the difference between the spot price of an asset and the price of a futures contract on it. Sign conventions vary between markets.
Relative value
Trading based on differences between related securities rather than on whether the whole market will rise or fall.
Directional trading
Taking exposure based on the expectation that a price will rise or fall.
High-Frequency Trading / HFT
Highly automated trading with very short time horizons and strong sensitivity to latency.
HFT is not one strategy: market making, arbitrage and other strategies can all operate at high frequency.
Medium-Frequency Trading / MFT
Systematic trading on horizons slower than HFT but faster than traditional longer-term investing.
There is no universal cutoff.
Low-frequency strategy
A strategy that trades relatively infrequently, holding positions for days, weeks or longer.
Part of Glossary Index · Previous: Orders, Matching & Execution · Next: Positions, PnL & Risk
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