23. Sniffing Strategy

Published at 1683714448.762126


“Sniffing” is a special group of algorithms to detect other trading algorithms. The sniffing strategy usually aims at continuously high-volume trading algorithms like TWAP, VWAP, and POV. It can also detect market-making algorithms or price momentum algorithms albeit less commonly used.

The input data of sniffing algorithms includes real-time tick data with the order book of all traded securities.

The key principle is to rely on matching orders and order books to find patterns that are more repetitive than arbitrary. Once the predictive model has been identified, if the above pattern continues, the sniffing strategy is considered to have identified another algorithm. Depending on the obtained data, it can mirror to open similar positions to take advantage of the information.

Trading algorithms appear in different forms below:

  • TWAP. The main characteristic of the TWAP algorithm is that the orders are separated over a fixed period of time. Sorting trading orders and finding transactions with similar volumes separated by a constant time period is a strong  indicator of TWAP.

  • Order splitting. The characteristic of order splitting is that many orders match in a brief time frame of under one second. A simple model reporting the number of executed orders over a 5-second period can give a strong signal of order splitting.

  • Market maker. The market-making strategy usually works very strongly at the bid price 1 and the ask price 1. All securities that continuously place orders at this bid and ask price usually involve a market-making algorithm.

  • Price momentum. Price momentum algorithms are often used in the derivatives markets. The common characteristic is to buy when the market is trending up and sell when the market is trending down. It usually creates a large price slippage. Monitoring repeated large slippage points over several days can give a reliable signal of high-volume price momentum algorithms in the market.

Key Applications

When detecting possible transactions of large organizations, the basic principle is to take positions in the same direction at a reasonable volume. It’s key to note that price changes too quickly can change the strategies of investors who are accumulating positions. So opening positions need to be strategic and rational according to the general market. Investors need to consider taking profits when the price moves too fast, or there’s no longer a support signal from the detected algorithm.

When detecting stocks with the participation of market-making algorithms, applying the right price momentum strategy at the right time can bring great profits.

When detecting a price momentum algorithm, using a scalping strategy will be optimal at points where algorithms with large volumes are involved.

Protect Your Systems From Sniffing Algorithms

Stealth algorithms are a group of algorithms to help execution algorithms avoid detection from sniffing algorithms. The basic principle of sniffing algorithms is to detect patterns. Adding more randomness in the execution will likely work well in defending sniffing algorithms.