In-depth Study of Market Maker Concept - Steemit Crypto Academy | Season 4 Week 6 | Homework Post for Prof. @reddileep by @ladyofpolicy.
INTRODUCTION
Greetings friends and everyone in cryptoacademy, I hope everyone is doing great. This topic is really something else I must say. It's of great importance that anyone who wants to venture into the cryptocurrency market should learn about the market maker in order to have a successful experience in the crypto space. I must say that this topic personally impacted me and without further argument I will like to answer the homework questions based on the knowledge I grabbed from the lesson.
QUESTION NO 1
Define the concept of Market Making in your own words.
For every shop,market or business venture,there is always a price for every single commodity one purchase and this prices of commodities doesn't fix themselves but rather the business owner determines how much he or she sells his goods depending on the price he purchased such product. The same thing is applicable to the cryptocurrency market, there is a price for every crypto asset and there are people, companies, individuals that influences and determines the price, they are called "the market makers".
Market makers are people who provide liquidity in the crypto market with buy and sell order using their own cash which they made from the market.
Since market makers provides liquidity in the cryptocurrency market,then the process by which liquidity is being created for a trade (buy or sell limit) order is called market making concept.
To explain further,in cryptocurrency market a buy and sell order of a particular crypto asset can be executed instantly or in the future. When a buy or sell order is initiated and completed at the spot with the current market price of that asset,the order is called market order. In market order, traders accept to buy or sell an asset at the current market price. In other words, traders take the price of the asset as it is at that particular time,also an order can be placed but won't be completed at the spot because the trader doesn't accept the current market price of that asset,in this scenario the order(limit order) will be added to open order and be carried out in the future when the price is good for the trader.
The traders that execute order at a current market price and those who set the limit order are called market takers.
The market making concept ensures that an active and healthy market exist for both buyers and sellers,they do this by ensuring that the bid-ask spread is small and fair enough for both the buyers and sellers. This market making concept makes it possible for orders be it market order or open orders are completed at the right time thereby earning more trust from the traders.
Finally, the price of buy and sell order of crypto asset is defined and the liquidity is provided concurrently in the market through market making concept.
QUESTION NO 2
Explain the psychology behind Market Maker. (Screenshot Required)
Each crypto asset has an order book and this order book is where the the price that is suitable and favourable for buyers and sellers over that particular asset is being recorded which is why each pair of asset has a price attached to it. Having known about order book,each time an order is being placed on an crypto asset,the matching system matches the order at the fulfilment of price and the current price at which the asset is bought or sold will be displayed. displayed.
Recall that in my question 1 above, I explained that some orders are completed at a spot while orders are completed in the future, but at times the case will not be either of the above. The case appears a bit different when an order is placed with the current market price of that particular asset and there are limited order in the market to merge such order,a delay in execution will occur and this is called slippage in trading. Slippage is a situation that occur when a market order get filled at a price different from the price at which it was taken. This particular scenero ushers in the market makers.
The market makers ensures that crypto assets are available to those who wants to buy,as well as buying from those who wish to sell. They are able to set their prices based on the volume of demand and supply of that asset. The market makers quote their prices, which are seen in the order book, during the price quotation they ensure that the bid prices are a little bit lower than the ask prices,as seen in the image below.
For instance, if a market maker set a limit order for a buy order at $30 and also set a sell limit order at a price slightly above the buy order let say $55, Then other traders try to place order at a current market price when the price reaches the prices set by market maker, the order will be matched immediately thereby helping the order that is taken at current market price to be filled instantly.
Market makers make profit from bid-ask spread of the submitted orders. If there are no market makers, trade orders will not go smoothly. Market makers help to provide great liquidity in market and thereby reducing price volatility in market. This in turn minimize the delay in the execution of order and I think this is a great psychology behind market trader.
QUESTION NO 3
Explain the benefits of Market Maker Concept?
Having explained what market maker concept is,we can clearly say that there are lots of benefits they offer to traders and below are few of the benefits of market maker concept.
Beneficial to traders with low capital.
Since they provide liquidity in the market, traders with little capitals are able to make profit from the liquidity that is provided by the market makers. They can make their orofit by entering a market to buy an asset at a low price and sell it off at a price higher than what they purchased it.
Increase the Number of Investors
Market maker concept helps to maintain healthy bid-ask spread and once there is a Bid-Ask spread in the market,it will attract more investors.
Provide Liquidity in Market
Liquidity is to buy and sell an asset at a current market value or ability to buy or sell an asset at any time. Market marker provide sufficient liquidity for an asset and thereby enabling instant matching of orders.
Reduction of Price Volatility and Slippage
Market marker concepts reduces price volatility which is mainly caused by slippage in market as a result, bid-ask spread is maximized in market.
Smooth Running of Trade
Market makers concept provides a smooth Running of trade in the market by making sure there is enough market orders to be matched at any time traders places an order and without it trading activities will be paused until there are sufficient orders to match together.
Increase Volume of Trading
An asset that has a high liquidity in the market always gets a high trading value while assets with low liquidity often has low trading value and market makers concept has a vital role to play here because one they provide enough liquidity in the market,it will attract a good number of investors and the volume of trading will increase.
QUESTION NO 4
Explain the disadvantages of Market Maker Concept?
Someone might wonder if something that has too many benefits like the market makers concept will also have a disadvantage,the answer is yes and below are it's disadvantages;
• Since the market makers are in charge of the market,they can at any point decide to manipulate the prices of asset by increasing the Bid-Ask spread there making the traders with small capital to suffer.
• The truth is that there is nobody in charge of the market makers and they provide liquidity in the market with their money so they can at any point decide to exit or pull out their resources from the market and this will affect the market.
• Since market traders are in charge of themselves and they are the ones that provide liquidity in the market,the liquidity will be for a short period.
• It may lead to Loss of Investment because the Market markers get their profit by trading against retail traders or small investor. The investment of small investors can be swallowed up by market makers especially if their concepts is not properly know.
QUESTION NO 5
Explain any two indicators that are used in the Market Maker Concept and explore them through charts. (Screenshot Required)
Two indicators used in the market maker concept that I will.like to talk about are;
• Moving average
• Relative strength index(RSI)
Moving average
Moving average is a type of indicator used to determine the trend of an asset. Traders do add two moving averages with different length on a chart of an pairs of asset to determine buy or sell signal. For a bullish trend to turn to a bearish trend the two moving averages must cross each other upward down and also for an asset that is in bearish trend to turn to bullish trend the two moving averages must cross each other from downward up.
Screenshot From Trading View Showing moving average Indicator On BTC/USDT trading Chart
In order to use this indicator perfectly, traders needs to understand various points such as the golden cross,which is the point where two lines cross each other to give a trend reversal . Most times on a chart, the lines tend to be above the movement of the price,this signifies a downward movement, while in situations where the two lines are below the movement of the price,then it is said to be an uptrend. I must say that traders tends to loss their money using this indicator because they have this fixed mindset that once the Golden cross appears,the next thing will be a trend reversal so once they see the golden cross they rush into the market hoping to make profit but at this point another golden arrow might appear which is caused by the market makers and cause a change in the market thereby causing the small scale traders to have a big load while they gain.
The Relative strength index (RSI)
This can be said to be a type of momentum oscillator that helps traders know the exact measurement of the magnitude of the market price when it moves within the range of 0 and 100. This indicator can be very deceitful as it moves in same trend as the price and also behaves like the price there by mixing things up and confusing the traders.
Screenshot From Trading View Showing RSI Indicator On BTC/USDT trading Chart
One thing about this indicator is that it shows when an asset is overbought or oversold. When an asset is overbought its value moves very high,above the intrinsic value and it is oversold when the price of an asset moves in such a way that the intrinsic value is higher,and the price is below,so for a successful and correct use of this indicator, a trader needs to understand the intrinsic values.
This particular indicator is used by market makers to make more profit by bringing out a signal for sell,so that traders can enter the trade,and immediately change it to a buy signal once the traders have entered the trade. Since this indicator follows the price,traders might tend to make quick decisions when using this indicator and it will result to a loss,while market makers make large profits.
CONCLUSION
I must say that all the lecture topic for this week are really wonderful and all thanks to the professor @reddileep for such an amazing lectures.
Indeed, the crypto market cannot function effectively without the market makers because their importance in the crypto market cannot be overemphasized.
Although this is my first time of hearing about market makers but I've always wondered how trades are being carried out the the market especially when I open my Binance exchange wallet and place an order and also get my money, it does baffles me but this lecture have resolved the curiosity and answered all my questions and am glad I took part in it.
Thanks.
Student.... @ladyofpolicy
Professor... @reddileep