[In-depth Study of Market Maker Concept]-Steemit Crypto Academy | S4W6 | Homework Post for @reddileep

in SteemitCryptoAcademy2 years ago

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Cover Page created by me, @msquaretk | Created with imarkup app


Hello everyone.
It's already sixth week in the Steemit Crypto Academy. This post is written to specifically answer the questions given by Professor @reddileep after his lecture on "In-depth Study of Market Maker Concept". He explained the topic extensively. So, I'm going to be attending to the questions given one after the other. Follow me closely.



Question 1


Define the concept of Market Making in your own words.

In cryptocurrency trading, traders can be categorized as sellers and buyers at a particular period of time. That's, at any point in time, there would always be traders who are selling and those who are buying a particular cryptocurrency pair. Some of the buyers and sellers buy and sell at the current price, the market price and some buy at a future price. The traders who buy and sell at future prices don't agree at the current price or market price and therefore have or decide the prices they would buy or sell at future.

It's pertinent to know that, the sellers and buyers must exit in the market at the same time. If this doesn't exist, then there won't healthiness in market. That's why you would see that the price doesn't just go straight on the chart. Both buyers and sellers are dragging price between themselves. The fight between the buyers and the sellers is based on price. Sellers will want to drag the price of an asset downward and at the same time, buyers will want to drag the price upward.

Now, traders who buy and at the current market price are usually called market takers. These people agree to buy and sell in respective of what the bid or ask price is. But there are people who don't buy or sell at the current market price. They are called market makers. Market makers are those who buy and sell at future prices. These people open limit orders. The orders which market makers place don't get executed because it's set for future prices, instead, the order would be placed and arranged in the order books. And once the price of an asset touch where it's set, the orders would be executed.

Market markers are liquidity providers. When the market is liquid, it will be easy to buy and sell the the cryptocurrency pair without its price being affected. Hence, the concept of market making helps traders and investors to enter into the market and exit the market. The liquidity the market makers provide is through their sell and buy orders which they have qouted or set.

The concept of market making could be used to make profit in the market when it's properly learned. Small investors could position themselves to trade with market makers because when the order set by market makers is executed, there's enough liquidity provided already. The orders which have been arranged in the order book will be executed once the price reaches the set limits.



Question 2


Explain the psychology behind Market Maker. (Screenshot Required)

Like it is said earlier, orders (buy and sell) are set in the market to be executed in the future at the buy an sell prices which have been defined based on the result of the decisions of the market makers. Some people believe once the sell and buy orders are placed, that market will just be moving well like that, but the smoothness of the market is as a result of the liquidity provided by the market makers, the buy and sell orders they have placed.

Market Makers create orders which will be filled at a defined prices of their choices. They create a guy order at a discount price and again create another sell order at a price higher than the first one so as to create liquidity in the market. Then, in between their orders created, there are people who take trades. Market takers are taking trades or executing orders at market prices in between the orders created by market makers.

For example, market maker created buy order at $50 price and then again created another order, in this case a sell order at a price higher than $50, say $55. So in essence, a buy order is created at $50 and a sell order is created at $55. It's therefore pertinent to know that market would not be empty between these orders created by market maker. There are people who would be selling and buying in between the two orders of $50 and $55 of market makers. This is made possible as a result of the liquidity the market maker has provided through their buy and sell orders.


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Fig. 1: Illustration of Market maker orders | Created with Canva app


Once the market Makers create their orders, the orders are then sent to the order book until they are matched. It is also pertinent to know that there is a party which can also contribute to the market maker concept. In cryptocurrency trading, these people are referred to as Whales. Whales are the people who owns large amount of cryptocurrency asset. These people can manipulate the market by significantly dragging the price of an asset down to induce the buyers and then at the same time, buy the asset and drive the price upward.



Question 3


Explain the benefits of Market Maker Concept?

Here, we will be looking at some of the benefits of market maker concept.

  • Market maker concept provides liquidity in the market.

One other the benefits of the market maker is that they provide liquidity in the market. Without liquidity, the asset can't be easily bought or sold. So, it's the provision of liquidity by the makers that makes this possible.

  • Stabilization of the Spread

Spread is the difference between the ask and bid price. Spread is made stabilized as a result of the influence of the market makers in the market. They provide liquidity which help in maintaining the spread so there's won't be unnecessary wide in spread.

  • Provision of entry price points for small investors

As result of the influence of the market makers in providing liquidity which maintains the Bid-Ask Spread, small investors can also have good entry points. If the spread is wide, small investors will not been able to participate in the market because they don't have fund which accommodate the spread. So, this is another significant benefit of the market maker.

  • Increase in the number of participants in the market.

Market makers have the ability to bring value of an asset at higher points. This will lead to the increase in the number of participants, especially small investors in the market.

  • Aid Smooth running of trades

Another important benefit of market maker is that they help in the smoothness of the trades. Without the help of market makers, transactions may be insufficient. So, makers are so beneficial in that both investors and traders perform their duties with the help of market makers.

  • Small investors can Profit from the concept

When small investors like us understand the concept of market maker very well and flow with them, we can make cool profit. But, we must learn how to recognize when they are in the market or when their operation in on in the market. This will make us to profit with their concept.



Question 4


Explain the disadvantages of Market Maker Concept?

In this part of the question, I am going to explain the disadvantages of Market maker concept.


  • Market maker may manipulate the price in the market

One.of the advantages of the concept is that, market makers may decide to manipulate the price. They may induce the small investors and then take their stop loss, even before going in the direction they want to actually go.

  • Small investors may lose their fund

This is another disadvantage of the market makers concept. If the small investors don't know which side the market makers will favor at a particular time, it may end up in losing their entire capital or margin. So, makers may decide to trick small investors and take their money. That's why small investors must learn how to go with them.

  • Some market makers provide liquidity for a short time.

Some of the market makers do provide liquidity for a short period of time. That's means they are not regulated. This is a big advantage as the liquidity which is needed is not provided for a long period of time.

  • Markers may give worse bid ask prices

Another disadvantage is that, market maker may decide to provide worse bid / ask price since they are the one provide liquidity in the maintenance of bid-ask spread.



Question 5


Explain any two indicators that are used in the Market Maker Concept and explore them through charts. (Screenshot Required)

In this part of the question, I am going to explain two indicators that are used in the market maker concept. Now, it's pertinent to know that we don't use indicators in the concept of market maker. The two indicators I am going to describe in this part of the lecture are relative strength index and moving averages. Let's start with relative strength index (RSI)

1. Relative strength index (RSI)

One of the popular indicators which traders use to make trading decision as to either sell or buy is relative strength index. The indicator is popular because of its usefulness in the cryptocurrency trading.

RSI is an oscillator-based indicator which shows when asset overbought and oversold. It is scaled form 0 - 100 and contains a single line which oscillates up and down in the indicator window.

0 - 30 is oversold region
30 – 70 is neutral
70 – 100 is overbought region


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Fig. 2: Relative Strength Index | Mt4 Platform


When the trend is bearish and RSI enters oversold region, traders consider that as exhaustion in bearish trend and believe that the trend will soon change to bullish trend. This period, traders keep accumulate the asset by buying and buying more with the sense that sellers would soon be opt out of the market and buyers will take over. On the other hand, when a a particular trend is bullish for a long period of time, and RSI enters overbought region, it is a sign that the bullish trend will soon change and sellers will take over the market.


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Fig. 3: Illustration of How traders use RSI | Mt4 Platform


In the figure above, we can see that as soon as the RSI enters overbought, the bullish trend changed to bearish trend. This is how retail traders use relative strength indicators. They will wait for RSI to enter overbought region or zone if they want to sell an asset and will wait for the RSI to enter oversold region if they want to buy an asset.


Now, knowing that retail traders use RSI to predict the market, market makers use this signal to manipulate the price. Let's see how market makers do use this.

Now, retail traders always look for the overbought and oversold region to make trading decisions. But it's pertinent to know that market makers may provide selling and buying pressures in those zones for short time and still continue in the direction which they want to go. Let me explain this very well. For example, if the market makers want to buy at the overbought zone, they would create selling pressure since they know retail traders would always want to sell at overbought region. And as soon as they create selling pressure, they drive the price of the market upside.

To understand this better, let's see the screenshot below.


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Fig. 4 : Manipulation of RSI sell signal by the Market makers | Mt4 Platform


As it is seen in the figure above, market has been in an uptrend, and retail traders would be expecting to sell the market when it is overbought. RSI entered overbought but market makers created selling pressure to the downside so that they could induce retail traders, take their money and finally buy the the asset. And it is seen that they successfully created the selling pressure and bought the asset.


2. Moving Averages

Moving averages is a trend based indicator which is used mostly by traders to predict the trade which an asset is. Moving averages is categorised into two.

  • Simple moving averages (SMA)
  • Exponential moving averages (EMA)

It's added to the main chart window. It comprises of two lines which follow the price movement of an asset. When the two lines cross in a Downtrend, this may mean that the current downtrend I about to shifted to the uptrend as the sellers are getting exhausted in the bearish momentum. So, it is a buy signal. On the other hand, when the two lines cross in an uptrend, it's a signalling that the buyers momentum are getting exhausted and that the sellers may take over very soon, so it's a sell signal. The crossing of the two lines is often reffered to as golden cross.

When the price of an asset is below the two moving average lines, the market is said to be in a downtrend and when the price is above the the moving average the market is said to be in an uptrend.
The screenshot below shows how a golden cross occurred on the chart of DOGEUSD in a downtrend and the trend changed to bullish.


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Fig. 5: Golden Cross in a Downtrend – Buy signal | Mt4 Platform


Also, see the golden cross that happened in an uptrend and as such as the golden cross took place, the price rallied down.


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Fig. 6: Golden Cross in an Uptrend – Sell signal | Mt4 Platform


Retail traders use moving averages to take trades when the golden cross occur. When the the golden cross occurs in a downtrend, they open a buy order because they know it's a signal that the current trend is over and also when the golden cross occurs in an uptrend, the open a sell order.


Knowing that the retail traders use moving average to take trades, market makers may actually take advantage of the signals from this indicator, moving average to manipulate the price. We will see how they use moving average I manipulating the direction of price.

Now, ideally, when the golden cross occurs, there should be a change in the direction of price. But a situation when there's a golden cross and there's no or a little change, then manipulation market makers have manipulated the price. For example, a golden cross occurs in an uptrend and retail traders have open sell orders thinking that the bullish run for a long period of time would change. There's just a little movement downward and the price of the market rallied up. That means, the market makers only created a selling pressure and later bought the asset to take the sellers out of the market and hunt their stop losses.

To better understand what I am talking about, see the screenshot below.


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Fig. 7: How Market makers use Golden Cross on MAs to Manipulate Retail Traders | Mt4 Platform


As it is seen in the screenshot above, the price had been in a downtrend for some time and the golden cross occurred. Initially, when this happens, the trend supposed to change from bearish to bullish. But look at what happened, the market markers just used the signal to deceive the retail traders. And as it seen, the price rally to downside after creating the buy liquidity and the trend still continued to the downside.



Conclusion


Market makers are the providers of liquidity in the market. They define the price they buy and sell the assets. Thanks to market makers that help small investors like us to be able to participate in cryptocurrency trading. Without them, small investors won't have the fund to bear spread. But the Bid-Ask Spread is maintained and kept very low as a result of the influence of the market makers in the market.

Thanks to Professor @reddileep for this great lecture. I have learnt one or two things from the lecture and I am eagerly looking forward to your next lecture.


CC : @reddileep

Written by @msquaretk

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