in this article of QuantVan, we are going to discuss another liquidity metric,” Price Gap”.
The Liquidity metric measures the amount of availability of orders at different prices near the last trading price. Optimally, there should not be any price gap between order prices within the order book regardless of the order volume.
To use Price Gap,
we should first set the definition of close proximity to the last trade price. E.g. ±4% of the last trade price.
A backtest algorithm should be designed to calculate the specific range of each pair. Of course, the first answer would be to place all orders as near as possible to the last trade price, but this will cause a lack of resources every time market surges or drops.
This means that not only the availability of orders in every price matters but also, the distribution of orders being placed surrounding the last trade price also plays a key role.
Figure 1 market-making orders placed disproportionately around the last trade.
It is worth mentioning at some points, the decision to make disproportionate market-making orders becomes crucial as the orders execute over time. To maintain the initial ratio, the market maker will favor the buy or sell side in different situations.
in this article, we mentioned another liquidity metric commonly called the bid/ask spread.