[In-depth Study of Market Maker Concept]-Steemit Crypto Academy | S4W6 | Homework Post for @reddileep
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Hello mates, we are in the 6th week of the 4th season of Crypto Academy already and so far so good. Thanks to all the professors who work tirelessly to impact us week after week. This is my submission for @reddileep homework task on Market Makers.
Define the concept of Market Making in your own words.
Crypto markets is just like every market where there are buyers and sellers who contributes to the general price behavior of the item or underlying asset. In fact, in crypto trading, price is very volatile and keeps changing every second as a result of market participants. Whiles one side of the market chooses to buy, the other side is selling and this is what sets the price of the asset.
Now, there is this group in the market who take both long and short positions of an asset with the motive of gaining some profit from the spread. These are market makers. Market makers enter the market and place a buy order usually below the best buying price. Other traders in the market begin to place their buy orders around this new bid price. Again they place a sell order usually above the best selling or ask price. Traders begin to place their sell orders around this new ask price. What this does is, it brings liquidity to the market. Market makers then take profits from the difference in the bid and ask price they quoted in the market (bid-ask spread).
The activities of market makers can be closely monitored when we study the charts of the asset very well and then we can make profits from the market maker concept too.
Explain the psychology behind Market Maker.
Even as they bring some form of liquidity to the market, market makers also have in their minds to make some profits from their activities. The market maker enters the market and places a buy order usually below the best bid price. Other market participants begin to place their order around this price and finally that order is executed at that price. Again they place a sell order usually above the best selling price. Other traders begin to sell the asset around this price pushing the price up an eventually the market maker's sell order is executed. They then take profits from the difference in the bid and ask price they set for their trade.
Let's see this from my Steem wallet considering the SBD/Steem pair.
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Here we can see the Bid price is $0.086042 and the ask price is a little above that at $0.86170 with a bid-ask spread of just about 0.149%, market makers can still make huge returns when they trade huge volumes.
Explain the benefits of Market Maker Concept?
- Providing liquidity to the market
Obviously the first advantage of the market maker concept is how it makes the market liquid. The activities of market makers provides liquidity to the market where there are enough sellers to meet the demands of buyers and trade happens quickly in a very liquid market.
- Increase traders in the market
Consequently as market makers provides liquidity to the market, it attract more traders to the market which in effect also promotes the underlying asset and its value.
- Reduce slippage
Market makers by their activities reduce the bid-ask spread which in effect decreases slippages. Slippage refers to any event in which a trader obtains a trade execution price that differs from what was expected.
- Reduces volatility of the asset
Market makers by their activities reduce the volatility of the asset by controlling the price of the asset.
Explain the disadvantages of Market Maker Concept?
- Likelihood of sending false signals
Sometimes market makers send false signals to traders in the market and those who fall victim are inexperienced traders or traders new to the market.
- Control of the market
Market makers sometimes manipulate and control the price in the market. This places them on top of the market and decide on what direction the market should go usually for their own benefits.
- Temporal liquidity
The liquidity provided by market makers in the market is temporal and usually not consistent. Once trade executes at the set price, liquidity levels in the market reduces.
Explain any two indicators that are used in the Market Maker Concept and explore them through charts.
Remember I earlier said the activities of market makers can present fake sell or buy signals in the market and those likely to lose from this are small investors. However, when we study the price behavior and movement of the assets through charts together with some technical indicators, we can escape this trap and make profits too.
I will employ two common but very important indicators to demonstrate this.
- Relative Strength Index (RSI indicator)
With the RSI indicator, we are able to tell if the asset has been overbought or oversold then we use that information to enter trade. An asset is said to be in the overbought region when it crosses the 70 mark on the indicator sending sell signal to traders. When the asset crosses below the 30 mark on the indicator, we say it has entered the oversold region and that sends a buy signal.
See screenshot below
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From the screenshot we see the asset entered the overbought region and like every other trader this means the asset's value will decline shortly and will enter a downtrend so the best thing to do is to sell. But in this case, the price rather went up after the short downtrend. This can be attributed to be activities of market makers who introduced selling pressure to the market and other traders sold the asset only for the market makers to come back and buy the assets sending the price up again.
- Stochastic indicator
We all know an asset has entered the oversold region when it is below the point 20 and it is in the overbought region when it crosses the point 80 on the Stochastic indicator. Furthermore, an asset in the overbought region means the bullish trend is weak and about to end whereas an asset in the oversold region corresponds with a weak bearish trend and the start of a bullish trend.
See screenshot below
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From the screenshot above, we see the asset in the overbought region signaling the start of a bearish trend, therefore the asset should be sold. However, the asset's price is seen to be going up instead and this can be attributed to be the activities of market makers.
Conclusion
Market makers are very key to the market and even as they provide liquidity to the market, they also have negative effects on the market. They are profit-oriented and once we study their activities closely and understand the charts very well we can also make profit from their activities.
Thanks to @reddileep for this insightful lecture.
Regards