[In-depth Study of Market Maker Concept]-Steemit Crypto Academy | S4W6 | Homework Post for professor [@reddileep]
Hello dear friends, hope you are all doing well. This is my submission for homework task set by professor @reddileep which is about Market maker concept.
Define the concept of Market Making in your own words.
Marking making refers to act of providing liquidity to the market so as to facilitate execution of trade between traders with ease. We know that, more liquid the market l, more is the ease of doing trade without effecting the intrinsic value of the security. Market makers are usually the brokerage firms but any individual or financial Institute can act as a market maker . Market makers buy/sell assets from traders and keep them ready for delivery to any third party . For example, a broker by the name of "A" purchased 100 tokens of an asset "X " at price of 100$ each. There is a seller "B" who wanted to buy token "X" and broker "A" Is there to facilitate the trade by selling token "X" at "$102" each. So broker is benefitted by Bid-Ask spread of price.
Market makers place limit order in the market. A buyer or a seller can act as market maker by placing buy or sell limit orders in the market. I used the term "limit orders" here because limit order get registered on the order book and get executed when the specific price is reached. On the contrary, market orders consume the liquidatity the market by getting filled instantly. Suppose i want to buy 1 BTC, i go to exchange and place order for 1 BTC in the market at market price. My order will be filled instantly and i am market taker because i consumed the liquidity of BTC in the market. The liquidity that i consumed was offered by some other market maker ( may be broker) . So it is because of market maker that i was easily able to get my trade executed.
Explain the psychology behind Market Maker. (Screenshot Required)
It seems a fascinating concept that market makers provide liquidity to the market that helped our trade get executed. We know that, for every trade of ours to get executed, there must bes ome third party on the other side who is acting as a liquidity supplier. But actually there is a definite psychology behind this phenomenon and that is the motive of the market makers to get benefited from the bid-ask spread of the market.
When a broker purchases X quantity of any token at n$ each and sells the same at $n x 0.1% . It doesn't seem a big to pay 0.01% extra but same percentage mounts to a good amount om huge volume. For 1000 token order, it would be 0.1 x 1000 = 100$ profit for broker. That's how bid ask spread govern the psychology of trading.
The table is turned by financial institutions whoae orders are so heavy that turn the market in their way and individual or retail traders are literally drained off and suffer psychological trauma. So in depth study of market and rules is mandatory to persist in the market.
BNB/USDT chart taken from trading view
In the chart above, preaume any retail investor to have entered market after consolidation and set stoploss below the consolidating zone. We can see that a single bearish candle hit the stoploss of retail investors to kick them off the market and than capitalize on huge bullish rally thereafter.
Explain the benefits of Market Maker Concept?
Market makers provide liquidity to the market and therefore facilitate ease of doing trade. We know that the centralized exchange have higher liquidity than decentralized exchange and therefore centralised exchange have huge user base then DEX. This is how liquidity influence user base.
Market makers determine the price of tokens. They can increase as well as decrease the price by pushing heavy volumes at target prices in desirable directions.
By increasing price of tokens, it provides opportunities for traders to participate and benefit from the market.
Market makers also determine the fate of new tokens launched in the market. Having participated in ICOs of tokens, market makers have potential to push high volume of collected tokens into market and make project a success. Reverse is also true.
Explain the disadvantages of Market Maker Concept?
Financial institutions have capability to manipulate the market. That is fatal for retail traders.
Market makers have potential to drain the funds of small cap investors by pump and dump.
Unregulated market makers can be fatal because they are only bothered about gains. They are least concerned about trading guidelines.
They have potential to influence liquidity of the markets which inturn has bearing on large strata of small and average cap rerail investors.
Explain any two indicators that are used in the Market Maker Concept and explore them through charts. (Screenshot Required)
Exponential Moving Averages.
Two exponential moving averages (long and short) are used to understand market maker concept. Crossover of short above long EMA is perceived as buy signal amd reverse and sell signal. These concept are known to all. However, the capability the influence the market is possessed by large cap market makers.
from trading view app chart showing market maker concept with EMAs
As indicated above , long EMA crosses above short EMA giving a sell signal. Retail investors either sell their asset on their own or their stoploss is hit and market makers thereafter push heavy volume into the market and capitalise to buy side. Retail investors therefore loss their funds to the short bearis move.
Relative Strength Index.
RSI is a Momentum indicator that measures the magnitude of the price to determine whether an asset is overbought or oversold. An arbitrary value of greater than 70 is presumed to be an overbought asset and indicates forthcoming bearish Momentum and is therefore a sell signal . Whereas a value less than 30 indicates the oversold i asset and is a buy signal. This fact is known to the large cap market makers as well as retail investors.
ETH/USDT Chart from trading view
In the chart above, we can see that RSI value above 70 is soon followed by bearish move down which is perceived as sell signal by users but we can see a short bearish move is followed by a huge bullish rally up. So retail investors either lose or exit with small profit and missed the mega price rally thereafter.
Market making refers to process of providing liquidity to the market by pushing heavy volume trades in either direction. The large cap market makers have potential to make markets blessing or curse where in retail investors are made to dance for no reason. Psychology behind market making is to profit from bid ask spread. Some indicators that are used by traders to govern their trades are also used by large cap investors to leech the retail investors for their personal gain. Enough of pessimism. Market making is a fascinating concept to keep market moving ethically.