In-depth Study of Market Maker Concept]-Steemit Crypto Academy | S4W6 | Homework Post for @reddileep
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The financial market like every other market is controlled by the demand and supply mechanism. The process of buying and selling is being facilitated in the financial market by market markets, helping traders and investors to place buy and sell orders. So what is market maker?
The word Market Makers is being used in the financial market to refer to a person/s or financial entity that actively provide the Bid and Ask price of a financial asset at any given point in the market. Most market makers are brokerage firms.
In a financial market, there are basically two types of buy and sell order. Immediate buy and Sell order, or Future buy and sell order. Now let me explain abit further.
When a trader decides to place a buy or sell trade in the market that activate immediately, it is refered to as a market order. Traders who do this are called Market takers, because he is placing the trade based on current market prices in the market and so taking the price the market is giving him.
On the other hand, traders who place a buy or sell order not on the current price in the market but a future price are Market Makers. These traders place a trade that will be executed/activated when prices get to a certain level in the market. These orders are usually refer to as Open Order or Limit Order.
Through this process of placing bids and ask price, market markers provide liquidity and depth in the market while profiting from the difference between Bids and Ask price also called Spread.
As earlier mentioned, Market Makers serve as liquidity provider in the market. They do this by creating or opening buy/sell orders in the market to facilitate the smooth functioning of the market. They are always readily available to buy and sell in the market at anytime.
It is worth noting that these Market makers are not just out for the sake of providing traders with liquidity in the market. They are aimed at making profit. The profit the market makers make is the difference between the Bid Price and the Ask price, which is the Bid-ask Spread.
And so, the market maker profits more when he buys at a lower Bid price and sell at a higher Ask price to increase the Bid-ask spread.
Let's take for example, a market maker create a buy order at $200. He is not going to place a sell Order at $200 but at a price higher, let's say $250 and the Bid-Ask spread is $50. These orders then get into the order book and permits traders to be able to trade in-between this price, thereby providing liquidity in the market.
Screenshot Steemit Wallet"
The above image shows the market situation of Steemit. The Bid price is $0.085574 while the Ask price is $0.085575 at the time of the post. The bid ask spread is $0.001%.
However, it is important to know that there is another group of Market makers who own great control of the market and manipulate the market. They are called Whales, traders who own significant segment in the market and manipulate the market to take advantage of small traders . Whales 🐋 manipulate the market to Influence the psychology of small traders, they might cause price to increase sharply, deceiving traders to think it's the beginning of an uptrend and get into buy trades and then price drops sharply. To be profitable in the financial market, it is important to fully understand the market maker concept especially whales manipulation Psychology. A good understanding of whales psychology will help a trader to be profitable.
There are many and huge benefits of market makers in financial market.
Liquidity. The most important thing and benefit of market makers is that they provide liquidity in the financial market. Through this provisions of liquidity, traders are able to trade at any time in the market.
Stability. As can be seen in the example of Steemit in question 2 above, market makers help to provide stability in the Market by providing constant Spread through opening Bid price and Ask price( in our case above 0.001%). This reduces the volatility of the financial asset.
Increase traders and investors. Market makers help to increase the number of traders and investors in the market by increasing the price of an asset. Trading in the financial market requires huge capital and most small traders do not have the Capital to trade but through Market, they are able to participate in the market.
Increase Value of Financial asset.
Market makers ability to increase price of a financial asset by increasing the Bid and Ask price can make price levels to increase, increasing profitability and consequently increase investors.Profitable Entry and Exit position. A good understanding of Market maker concept can help traders know time when market makers are active. This can help traders with strategic entry and exit positions to make profitable trades.
Market manipulation. As I earlier explained, some market makers are sometimes whales who own a significant influence on the market. These whales are capable of manipulating price and causing small traders to enter wrong position thereby loosing their money. This is one of the biggest disadvantage of the Market maker concept, the ability to manipulate the market.
Lack of regulation. The financial market especially forex and Crypto currency market is not fully regulated. So most market makers provide short term liquidity which is not good for the traders and market.
Reduce value of coin. Market makers can actually bring down the value of a good coin through their ability to influence price by providing swing price movement.
Conflict of interest. Market makers can present conflict of interest since they might trade against small investors in order execution.
As I already mentioned, the market makers seek to manipulate small traders and trade against them to make profit. Market makers are able to give fake buying or selling pressure to traders. They do this sometimes through the use of technical Indicators
To answer this question, and see how market makers use technical indicators to Influence the market, I will use the RSI and Simple Moving average.
Stochastic oscillator indicator
This is one of the most popular technical indicator in the world. It is used worldwide by traders to analyse price movement and entry positions. This is why it is a good tool used by Market makers to manipulate traders.
Stochastic is an oscillator indicator that shows overbought and oversold positions in a market. The Indicator ranges from 0-100.
- 0-20: Oversold position
- 30-80: Normal trading position
- 80-100: Overbought position.
Using this Indicator, traders are able to enter the Market at profitable positions.
During a downtrend, price are falling as so does the Stochastic oscillator indicator. When the signal enters the Oversold zone, traders start accumulating the asset bit by bit anticipating a rise in price that is a bullish reversal.
Conversely, the same thing happens when the market is in an uptrend and enters the overbought position. Traders start entering a sell order in anticipation of a drop in price.
How do Market maker concept use this Indicators.
For a successful trade, traders are also on the look out for overbought and oversold zones using the RSI indicator. The market makers can force a short term buying or selling pressure on an asset to make traders enter a position and then the market reacts in a different direction.
Screenshot"
Let's take an example of DOGE/USDT pair. As you can see the Stochastic oscillator indicator is in an overbought position. Market makers have influenced the movement of price to the overbought zone, using this Indicator, traders will get into a sell order expecting price fall. . As can be seen from the image, price falls very sharply and continue to rise causing retail traders to loose out on this trade.
Bollinger bands indicator
The Bollinger bands is one of the Indicators that is also widely used by traders all over the world. They are trading indicators used to identify entry and exit positions in a financial market. The Bollinger bands consist of the moving average line and two trading bands below and above price movement. These bands contract or expand base on price movement in the market.
When price consistently touch the upper band, it is considered that the asset or Crypto currency pair is in an overbought position and conversely, when price continue to touch the down bands, the asset is considered to be oversold. This positions constitute entry and exit points.
How Market makers concept use this Indicator
Now, having a good understanding of the Bollinger bands and how it works, it is important to note how Market makers use this Indicator.
We already know that when prices touch the upper band, it indicates overbought positions, a buy exit and sell entry and when it touches the down band then the reverse is true.
Therefore, Markets makers can induce a sell pressure forcing the price chart to touch the upper band to force traders into placing a sell order expecting price to fall and price instead continue to increase. Conversely, Market makers can induce a buy pressure by forcing price to touch the down bands
Screenshot"
As can be seen from the image above, the price chart is touching the upper band but price keeps rising and drops sharply and then continue to rise. It can be seen that using the Bollinger bands, Market makers are able to manipulate prices to touch the upper band influencing traders to enter a sell order from expecting a trend reversal, however, prices keep rising.
The Market Maker concept us a very important and vital concept for traders to understand before fully engaging in trading. Thanks to the activities of market makers, the market is able to function properly and liquidity is always available for the smooth functioning of the market.
However, it is important to understand the psychology of market makers and guide against exploitation from them. As a perfect understanding of this Concept will help traders make profitable moves in the market.
I want yo thank professor @reddileep for the amazing lecture. It was great being in you class.
CC. @reddileep