[In-depth Study of Market Maker Concept]-Steemit Crypto Academy | S4W6 | Homework Post for @reddileep
Thank you very much Prof @reddileep for this wonderful lecture. I learned a lot.
Define the concept of Market Making in your own words.
In the cryptocurrency world or market, trade consists of two actions, buying and selling. At any given time, the trading of cryptocurrencies is ongoing. Some of these trades are executed with the present price, market price, and some others are executed at a future price. At any point in time trades get executed, and this is because some individuals or groups with some sort of high capital are always around to buy or sell those cryptocurrencies on the exchange platforms at any point in time. They are called the market makers.
These marker makers are usually brokers or some local individuals who have connections to exchanges or trading platforms to give liquidity and also generate profits.
Brokers in cryptocurrency are organizations or people who act as intermediaries in placing orders for investors for a commission. Those investors give them more funds and with these amounts of funds, the prices of assets can be affected. Here are some examples of cryptocurrency brokers; eToro, Gemini, Coinbase, Voyager, etc.
For a trade to be executed, there should be an entity at the opposite side of the trade that is buying or selling. This mechanism enables sellers to be matched with buyers which makes trading easy and very convenient. Sometimes the buyers outweigh the sellers so there won’t be enough sellers on the other side of the trade to be matched or vice versa, when this happens, the market makers bridge this gap by buying from those selling and selling to those buying. The market makers buy or sell at the quoted prices.
In trading we have the bid price, the ask price and the ask-bid. The bid price is the price at which the asset is sold to the market marker by the trader. The ask price on the other hand is the price at which the asset is bought from the market maker by the trader. The ask bid is the profit made by the market makers from the trade, and it is the difference between the bid price and the ask price.
For example, the market maker can decide to sell an asset for $1.03 which is the ask price, and also buy the asset for $1. There is a difference of $0.03 and that becomes the ask bid and it is also the profit the market maker makes.
They are also prone to losing profits as the price movement may not favor them when it moves in any direction, this way their losses may be cared for by the platforms they work on. Brokers are not the only entities that can affect the price of an asset.
Market makers are very essential. Without them, a trader will have to wait to be matched with another trader who is willing to trade with you, this will cause the cryptocurrency market to be very slow.
Their work has been eased with the introduction of automated market makers, they are programmed to give liquidity and quote ask and bid prices. They are usually on DEXs (decentralized exchanges) they don’t have a working limit like the brokers and other market makers. The traders and other users provide the liquidity pool that it uses to trade automatically with users.
Explain the psychology behind Market Maker. (Screenshot Required)
Trade orders are already set in the crypto market to be executed in some future using the prices set by the market makers. The market makers provide liquidity by placing buy and sell orders to ensure that the market runs conveniently.
These market makers place sell orders at a price then create another buy order of the same asset at a lower price making a short or placing a buy order at a reduced price and place another sell order at a higher price making a long. Also, we have market takers, these people execute orders or take trades at the market price at the interval of the orders placed by the market makers.
For instance, a buy order is placed at a certain time at a price of $20, and a sell order of a higher price is then placed at a price of $30. So, the buy order is $20 and the sell order is $30. In between these two orders of the market makers, other traders will be trading as well. They are able to do this through the provision of liquidity by the money makers from the orders they placed.
created by me
After the market orders are placed by the market makers, they are then recorded in the order book. These orders wait in line to be matched. There is also another factor that can influence the market maker concept, they are known as the Whales. Whales are individuals or entities who are holders of a very large amount of cryptocurrency assets. Whales influence the market by sometimes purchasing a very level of the asset at a very high price, this causes a rise in the price of the asset, and bidders are compelled to also increase their bid prices in order before it will be possible for the buy orders are filled by the sell orders. This increases the price of the asset significantly.
Explain the benefits of Market Maker Concept?
Let us now dive into the essence of the Market maker concept.
• It smoothens the operations of the market: trades in the market run smoothly because of the presence of market makers. Without them, the orders may not be sufficient in order to be matched. this would have caused a halt in the market before the orders are enough to be matched.
• It aids in bringing in new investors and traders into the market. Market makers are able to give value to assets of low value and make them more valuable. This causes most especially new traders and small investors to enter the market.
• It offers liquidity to the market. The liquidity of the market is the ability of assets to be bought or sold easily at any point in time at a present market value. An asset cannot be purchased or sold without liquidity and the Market maker concept prevents this by providing liquidity.
• It reduces price slippage and price volatility. The market maker is able to bring down price volatility which is usually brought about by slippage in the market. This in turn helps in increasing bid ask spread on the market.
• The market maker concept helps in increasing the trading volume of an asset. The higher the liquidity of an asset the more people invest in it. Low liquidity of an asset is mostly goes with wide spread, and this influences the volume of orders received. High liquidity on the other has a small spread which causes a high volume of orders.
• The market maker concept gives entry price points for investors with low funds. Due to the fact that the market makers are able to provide liquidity which stabilizes the bid-ask spread, investors with low funds have a chance to get good entry price points. A wide spread will result in low fund investors not having sufficient funds to support the spread.
• It keeps the spread steady: the effect of market makers on the market helps in stabilizing the spread and they do this by providing liquidity.
Explain the disadvantages of Market Maker Concept?
Just like other things, the market maker has disadvantages as well. Here are some of them.
• Some market makers give liquidity for a very limited time: Most unregulated market makers provide liquidity for a very limited or short time. This does not help as the liquidity needed might not be provided long enough.
• Price of the asset may misbehave: market makers can cause a fall in the price of an asset. Low funds investors may be scared to place buy orders because the sell orders by the maker may be high. In this case, buy orders will become very low and the sell orders will be high. This will cause the price of the asset to be in a downtrend.
• The market maker concept can cause one to lose their funds: trading in opposition to other traders and investors is how market makers generate their profits. So, if one has not studied and understood the market makers concept, they may be lead to lose their capital.
• the market makers may deliberately change the price of an asset for their own gain: the market makers due to selfish reasons may alter the price of the market. They may lure low funds investors and receive their stop loss before they allow the price to move in the direction they prefer.
Explain any two indicators that are used in the Market Maker Concept and explore them through charts. (Screenshot Required)
When it comes to cryptocurrencies, indicators are the technical analysis tools used by traders, investors, etc. to analyze a cryptocurrency coin to make good decisions and generate profits. There are a lot of indicators that can be used for analysis on a chart., here are some of them;
• Bollinger Bands
• Moving averages
• Relative strength index
• Vortex indicator
• A/D (accumulation/distribution) indicator
• Random index indicator
• Etc.
I will explain Random index indicator and moving averages.
Random index indicator
This indicator is also known as the stochastic oscillator and it is used in the market maker concept. This indicator is used to find the resistance and support level of a cryptocurrency asset on a chart. It is able to provide overbought and oversold signal and it is also capable of determining the market trend of a cryptocurrency asset.
This chart is a 1minute timeframe of BTCUSDT. This indicator consists of two lines, the K and the D line. These lines help in detecting the changes in the behavior of buying and selling as they move along with the price. This indicator can also determine if an asset is overbought or oversold. When the K and D line crosses at the overbought region it is usually followed by a downtrend in the market and it gives a sell signal. When the lines cross at the oversold region, it is followed by an uptrend and a buy signal is given.
From the chart shown above, the K and D lines cross at the overbought region that is circled black. The coin dropped for some time and bounced back against the indicator in a different direction. That short fall in price was because a market maker giving liquidity to the market to cause a little downtrend but the indicator signaled a downtrend hence, a sell, so traders and investors looking at the indicator placed sell orders and the caused the little downtrend but the price reversed to an uptrend.
Next, I let us look at the other indicator, moving average.
Another good indicator that can go along with the market maker concept is the moving average. This indicator gives the trend of an asset. It is normally two moving averages of different lengths that are combined to give price trend signals which can be used to make buy or sell decisions.
For a bullish trend to occur the shorter MA crosses the longer MA from below and for a bearish trend, the shorter MA should cross the longer MA from above.
This is a BTCUSDT chart with the orange line as my short 50MA and the blue line as my long 200MA. It can be seen that at a point the orange line (50MA) crossed from below which is supposed to be an uptrend but it went up for a while then changed course to a downtrend. This happened because the market makers were trying to give liquidity to the market for a short uptrend so the short MA crossed from below and signaled an uptrend so traders and investors based on the signal will buy the asset.
Conclusion
The market maker concept is one essential concept that ensures the smooth operation of trades in the market by providing liquidity. Their operations are needed for a smooth-running market. To have a better feel of the benefits of this concept and gain more profits, one has to understand their operations and also be careful of their price manipulation as they can cause one to lose their funds.
Hello @gentles,
thank you very much prof