In-depth Study of Market Maker Concept-Steemit Crypto Academy | S4W6 | Homework Post for @reddileep

I am delighted to participate in your class this week 6 of cryptoacademy season 4 professor @reddileep.

Here below is the entry of the assessment task.

Q1

Define the concept of Market Making in your own words.

THE CONCEPT OF MARKET MAKING.

Most times we wonder, how it is possible that we can swap, buy or sell our cryptocurrencies whenever we want and the transaction gets completed in seconds or minutes. This is possible because someone or a group with high capital stays standby to buy or sell cryptocurrencies at the exchanges at a given time. These persons or groups are known as market makers.

For a trader to buy or sell cryptocurrency, there must be someone at the other end of the transaction willing to buy or sell. The market making concept allows for easier transaction, it allows the market makers to match sellers with buyers and vice versa. In case there are limited buyers when there are sellers or limited sellers when there are buyers, market makers fills the lacking role by buying from the seller or selling to the buyer. However the market makers decides or makes the market buying quoting prices they wish to buy or sell. This concept inspires confidence in the exercise of trading, if the opposite were to be the case, trading cryptocurrencies would meet with lower adoption.

The price at which a trader is buying crypto from the "market maker" is known as the "ask price." The price at which a trader sells crypto to the "market maker" is the "bid price." The difference between the ask price and the bid price is known as the "ask-bid spread" and this represents the profit of the "market makers".

Let's take for instance, "market maker is willing to buy " crypto A" at the price of $2 usd. This is the bid price. In the other hand, "market maker" is willing to sell "crypto A" at the rate of $2.05. This is the ask price. If a trader is selling, he sells at $2 but if he wishes to buy, he buys at $2.05. $0.5 difference is the profit of the "market maker".

When there are much buy or sell orders placed on an asset, we say that the asset market is liquid. It shows how people are interested in the particular crypto asset. The possibility of being traded at ease is made possible by "market makers" who are always ready to buy or sell their asset as at when needed. When much persons are transacting using the crypto it adds to it's capitalization, coupled with high volume of investment especially by "market makers" adds to it's liquidity and affects the price.

Consider what will happen suppose there are no such persons. It means that to buy or sell cryptocurrencies one will need to wait to be matched to another trader willing to transact. For example, A person desiring to sell needs to wait to be paired to a person willing to buy and vice versa. Such methodology will drastically slow down the market ecosystem. Market makers offers brokerage- buying and selling of assets whenever a trader places an order.

WHO ARE MARKET MAKERS?

These are individuals traders or companies with high volume of money whom literally makes the market by determining the price at which securities are bought or sold.

Market makers decide at what price, they are willing to buy or sell an asset. When there are more of people willing to sell an asset, market makers lowers the price at which they are willing to buy. They do this buy setting a buy limit order. When sellers agree to their price it becomes the market price of the traded coin.

When there are more demand of the asset than supply, market makers raises the amount they are willing to pay for the asset in order to lure people to sell their assets and these causes the price to rise.

Q2

Explain the psychology behind Market Maker. (Screenshot Required)

Just as every trader hopes to make profit, so is the market maker. Because they trade with high volume, they hope to profit from small percentage of difference in the bid-ask-spread.

fig 1. solusdc binance app.

the image above shows a difference in bid and ask price which represents the market makers profit.

•••
As I illustrated above, suppose "crypto A" bid price is $2 and it's ask price is $2.05. A market maker makes a profit of 0.05 usd. On a liquid market, this may be a big money. Suppose 0.05 is made from 2 million unit of "crypto A" sold in a day, we will be talking about $200,000 for the day.

The psychology of a market maker is to make small profit from trades, yet when this profits are multiplied with the total number of units sold out for a day, it may turn out to be huge profit. That is why, as market has more liquidity, the market makers reduces the bid ask spread but when there are no much Liquidity in the asset, the market maker take more for bid-ask spread.

fig .2 quote method and spread.

While a market maker may profit from buying low by deciding the market buy price, they also profit from the ask-bid spread. However their job can be very risky since the market can go against them.

Q3

Explain the benefits of Market Maker Concept?

BENEFITS OF THE MARKET MAKER CONCEPT.

• The beauty of the market making concept is that it facilitates faster transactions. Traders can execute buy and sell orders at convenient. For example, When a trader initiates a buy order and there are no matched buyers at present, the market maker buys from the trader to resell at other times. When the opposite is the case, the frustration might cause the trader to abandon trading the asset and in general, crypto trading will be met with low adoption.

• The market makers adds to market liquidity.
  A market is liquid when there are more buyers and sellers. It means that whenever you have an asset to sell, someone is there to buy. So if you wish to enter a trade by placing a buy order and there is no one to sell to you, you will not be able to buy at the current desired price. So is the case when you hope to exit a falling market and no one is there to buy. Therefore without the market makers, it will be difficult for traders to enter and exit trades at when desired. This could result to more cost trading crpto and more risk.

• Another benefit of the market maker concept is the volume at which the market makers trades. Without them the volume will be affected and this could affect the crypto value.

Q4

Explain the disadvantages of Market Maker Concept?

• One disadvantage of the market maker concept is that the price may be slightly higher when buying as at when compared to market without market makers.

• When the market is not regulated, the market makers may cheat, there are possibilities that they could widen the spread and make more profit.

• Without regulation, the asset would be highly volatile due to the quotes of the market makers.
  For example, in regulated markets like forex, when a market maker quotes an asset's bid or ask prices, they are expected not to change the price untill at least they have completed 1000 transactions on the current price. On unregulated markets, things can be different.

Q5

Explain any two indicators that are used in the Market Maker Concept and explore them through charts. (Screenshot Required)

Usually a market maker is a whale with high investment. When there are higher demands of an asset and low supply, a market maker tends to offer a relatively high bid prices to lure small investors to sell. The more the retail investors keep selling, the more the market makers keeps lowering the prices untill they have bought a large chunk from the retail investors. Now majority of the asset is with the market makers and there is low supply and high demand. It is therefore time for the market makers to hike the prices. While the market makers cannot ultimately control the market, however they create events that spike reaction by the retail investors and indirectly being in control of the game.

Market maker concept when followed will enable a trader see what the market maker is seeing and follow what he is doing. It is advisable not to work against the whales but rather follow them. To do this we make use of technical indicators.

Among the good indicators to use in market maker concept includes trend following indicators such as the Bollinger bands indicator. The benefit of using trend indicators is to help a trader understand the trend direction. The trader could see where the market makers are pushing the price towards. Trend following indicator can spot reversals therefore determine when an asset is taking an opposite turn to it's former director.

How Bollinger bands work.

Bollinger bands has three bands, the upper, middle and lower bands. The upper bands serves as resistance and lower bands serves as support. The middle band can act as both support or resistance depending on the dominant price movement. The shades and the bands of the Bollinger can contract or expand signaling trend strength. The asset is trending when the bands expands and not trending when it contracts.

USING BOLLINGER BANDS ON MARKET MAKER CONCEPT.

Our goal here is not to spot out entry and exit points which Bollinger bands can equally help but to identify price direction and strength of trend. This will enable us understand in what direction the market makers are pushing the trend.

• When the shades and bands of the Bollinger bands points towards up, it means means an uptrend. The opposite is the case for downtrend.

• When the shades and bands of the Bollinger bands widen, it indicates a trending market and when it compacts, it means the asset is not trending.

• Breakouts when the price chart touches on the upper Bollinger shows overbought while breakout or when the price chart touches on the lower Bollinger it indicates oversold. And each points to a possible change in trend.

Bollinger bands investing.com.

In the figure of XRPUSDT above, the first marked breakout led to bullish reversal. We saw how the bands of the Bollinger points upward. On the second marked breakout is a bearish reversal. We saw the Bollinger bands slope downwards. With this, we have understood the market movement and direction.

RELATIVE STRENGTH INDEX (RSI) INDICATOR.

Another good indicator to use for the concept is a momentum indicator like RSI. RSI measures the pace at which price of an asset changes to determine it's overbought or oversold positions.

The indicator has a reading from 1-100%. When an asset price reads 30 or below in RSI indicator, it shows oversold and when it reads 70 or above it indicates overbought.

The indicator informs a trader about the trend and possible drop or increase in price of the asset being analyzed helping the trader identify the assets overbought or oversold positions.

RSI investing.com

In the figure above, market took a long downward movement after crossing the overbought area in the first marked area. A long bullish move is observed in the second marked area when the RSI crossed the oversold area.

BENEFITS TO MARKET MAKER CONCEPT.

• A trader can see the pressure in the market and understand which pressure is winning, the buy pressure or the sell pressure.

• A trader could be ready to follow the market maker depending on the direction they have manipulated the price to go, up or down.

• The trader will know when the market is changing direction.

COMBINING TWO OR MORE INDICATORS GOOD FOR MARKET MAKER CONCEPT.

In most cases traders combine two or more indicators to follow the market. For example if a trader is using an indicator like traders dynamic index (TDI), he is invariably using three indicators at a go. TDI comprises of the two indicators I have discussed above plus moving average.

Here below I have added up the two indicators which I have discussed to indicate a more stronger signal.

RSI, Bollinger bands, investing.com

In the image above, one indicator (RSI) serves as a confirmation tool. The labelled A and A, B and B, and C and C shows places where RSI confirms the Bollinger bands signal.
Each reversal happens after a breakout occured in the Bollinger. There are yet other confirmation that can be observed in the chart.

TAKEAWAY.

• Market makers are individuals traders or companies with high volume of investment charged with deciding price quotes, adding liquidity and ensuring smoother and easier transaction within the trading ecosystem.
• The psychology of a market maker is to profit from the spread. Though the spread amount appears small, but when multiplied by the volume sale per day it turns out to be a tempting profit. He also hopes to buy as low as possible and sell as high as possible.
• The market maker concept is the practice of following the market makers as they move the market. Using trend following indicators like the Bollinger bands, momentum indicators like RSI, volume indicators or combining two or more indicators will help a trader understand the market makers push of the market.

Image references.

Binance app.
Investing.com