[In-depth Study of Market Maker Concept]-Steemit Crypto Academy | S4W6 | Homework Post for @reddileep
Hello,
This is a homework post for professor @reddileep .
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Question : 1
Define the concept of Market Making in your own words.
Answer :
Who are Market Makers?
Market makers refer to an individual or firm which actively trades in both sides of market using its own account. Market makers provides liquidity to markets and make profit from the bid-ask spread. To put in more simple way, Market marker is one who buys and sells big amount of asset in order to facilitate liquidity in market and also ensure the smooth running of market. An individual can be market maker but, that individual required a large amount of quantity of different assets to complete the large trading volume, that is why market makers are usually large firms.
Market makers have a number of assets that they deal with. By displaying a sell or buy quote, they will execute trades at those prices rapidly, these market makers will create a straight way for placing trades.
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Market makers will help to stable market prices by finding balance between supply and demand. When cryptocurrency markets are more volatile, market makers need to remain stable and will continue to take responsibility for the cryptocurrency market's performance, and this process will open them to larger risks. This is why they will make/maintaining a bid-ask spread on asset, and make money from spread because they enable you to trade and also compensate the risk of buying/selling any asset that may devalue.
What is Market Making?
It is stated as :
As soon as any order is received from the buyer, the market maker will sell the desired asset to the buyer from its own account and completes the order. Similarly, when a order is received from seller, the market maker will buys the asset and completes the order. This whole process will increase the liquidity of the markets. This is known as Market making strategy.
Important point about market making :
Market makers helps to provide liquidity in markets.
Market makers will displays the buy and sell quotes for number of assets.
Once the order is received, market makers immediately completes the order from its own account inventory.
Market makers will make money by maintaining the spread in asset.
The market makers will reduce the time required for making trades.
Why is Market Making Important?
In general, market makers will help markets by maintaining the efficiency of their positions. This makes market makers very important for markets. If there are no market makers, there would not be many transactions in market.
This is the reason why market makers are important to markets. And, it is also expected that they will influence the markets even in the future.
Question : 2
Explain the psychology behind Market Maker. (Screenshot Required).
Answer :
As we already know that market makers will provides liquidity to market and maintains the bid-ask spread. This is helpful for small trader to make trades in easy and fast way. But market makers risk their own money to maintain the spread. Of course, nobody risks their money for helping others. They will make profit generally from the bid-ask spread.
In general, market makers charges higher ask price for asset than the bid price. This difference between the bid and ask price is known as spread and this spread is the profit for market makers. Usually, this spread is very low to make profit but the market makers trade in large amount because of that this small spread is enough for them to make large profits.
The bid-ask spread is the compensation for market makers for the risk they took to maintain the spread. Because, sometimes, trades can go against the market makers' trading position.
As we all know that market makers will make profit from the bid-ask spread that they maintain in any asset. In some assets the bid-ask spread is more when compared to other crypto assets. The lesser the bid-ask spread, higher the liquidity in asset. Similarly, higher the bid-ask spread, lower the liquidity in asset. Here, you can see the example of both kind of spreads : large and small.
The image is from my binance account of asset YFII/BNB. You can see that the bid-ask spread is about 1.17%. You can also see the latest bid and ask price in the order book below.
Here, you can see in the picture that the bid-ask spread of asset is quite large when we compare it to more liquid assets. Hence, higher spread means lower liquidity.
The image is from by binance account of asset SOL/BTC. Here, the bid-ask spread is about 0.03%. You can also check the latest bid and ask price in the picture.
Here, you can see in the picture that the bid-ask spread of asset is very small(0.03%) when compared to less liquid asset. Hence, lower the spread means higher volatility.
From the given two examples the SOL/BTC has more liquidity because it has lower bid-ask spread.
Let us look at an example how market makers use these spreads :
The market makers use bid-ask spread to make profits. They always decides ask price and place sell order above current price and market maker decides bid price and place buy order below current price.
Here, you can see the image of BCH/BNB asset. The bid price is 1.29 and the ask price is 1.292. The difference between bid price and ask is approx 0.15% and this is the profit for market maker. Although, the profit margin is very low but market makers trade in large volume hence making good profit. Because when this small margin is multiplied by large volumes then it will result in good profit.
Once the orders are initiated from the market makers, they will go into the order books of asset where they are matched. There are some other members that contribute to market-making concept. These members are known as the Whales in crypto world. These members have a large volume of different assets and they usually manipulate the markets. They will try to trap small traders for thier own good. They intentionally drag the price of asset higher/lower so that small investors initiate their trade in same direction and after some time big players convert their positions and small traders are trapped. Whales make money by trapping small investors.
The market makers do not always makes profit but sometimes they are also stuck with assets. Here, we discuss the psychology used by market makers to avoid loss. The factors every market maker keeps in mind are the factor by which they lose their money. So, let us look,
The primary risk which market maker can face is a decline in value of asset after it has been purchased from the seller and before it is sold to any buyer. In case of any volatility in market , the market makers always stuck with the wrong trades.
Another risk for market maker is not to have the latest info about the asset. To put it in simple way, Market makers will able to manage risks only if it is possible for them to receive the latest informations and respond to them quickly. Otherwise, market positions will go against them in few seconds and they lead to huge losses.
Hence, it is very important for strong markets to have strong market makers that survive without making huge losses.
Question : 3
Explain the benefits of Market Maker Concept?
Answer :
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Let us discuss all the benefits one by one :
🔸Liquidity🔸
Most important benefit of market makers is that they provides liquidity in market. Higher the liquidity means, anyone can complete orders easily and in a faster way. And, without liquidity it is difficult to make trades that easily.
🔸Stable prices🔸
Market makers create a bid-ask spread for the asset and that will help to make price of asset stable. Market makers provide enough liquidity that will helps to maintain the spread in asset and they will keep in mind that spread would not be unnecessarily wide.
🔸Faster trades 🔸
As we all know market makers provide liquidity and due to that liquidity it is possible to make trades more easily and faster. If there is no liquidity in the asset then it is very difficult to make trades possible.
🔸Mitigation of price swings🔸
Market makers will create a bid-ask spread for the asset, and this spread will helps them to stable the price of asset and this spread also helps them to reduce the larger price swings.
🔸Reduce slippage🔸
Slippage happens when we place an order at some price level and it will be executed at some other levels due to volatility in market. Because their is a liquidity in market, this will cause volatility and price slippage is bound to happen. But this slippage is reduced to a large extent because of spread that market makers maintain. Because price of asset is in the spread this will reduce the larger slippage.
🔸Orderly Entry/Exit for traders🔸
Market makers maintain the spread by providing the liquidity, this will helps small traders to find entry/exit points, otherwise, if this spread is large small traders find it difficult to accommodate the spread.
Question : 4
Explain the disadvantages of Market Maker Concept?
Answer :
As we know nothing is perfect, everything has pros and cons. So, some of the disadvantages of market maker concert are :
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Let us discuss all the disadvantages one by one in a detailed manner :
🔸No regulations🔸
As we know that market makers are not regulated because of that sometimes the market makers provides liquidity from small time durations. Due to this, small traders faces problems because the liquidity is not provided by market makers for larger time frame which is required to complete the orders.
🔸Manipulation🔸
This is another disadvantage of market makers concept. Because they are the liquidity providers and maintains the spread, they can manipulate the price of asset. They may use small traders for their benefit, by sending them in wrong direction of trade that market makers created.
🔸Less knowledge about market maker🔸
In market we don't about the opinion of market maker. We don't know which side of trade market maker is supporting. So, small traders must get proper knowledge about market maker concept and learn about how to go with market makers. Otherwise, trader will risk their money.
🔸Traps🔸
Market makers are the liquidity providers and they easily trap small traders. Market makers can bring the price of asset very high/low. This happens because when they trade in buy side and due to large amount is traded by them price might go in the direction they want and in this process small traders will act quickly and they also buy the asset making price go even higher, when price is enough high market makers convert their position and small traders are trapped.
Question : 5
Explain any two indicators that are used in the Market Maker Concept and explore them through charts. (Screenshot Required).
Answer :
There is a difference between how normal trader sees a market and how market makers sees the market. A normal trader usually analyise market using indicators, trend lines, resistance/support levels, patterns,....etc. This list is very large. And this kind of analysis is known as horizontal market analysis. In this we take some historical price data and draw trend line, try to find patterns. And based on this analysis of ours we initiate our trades but market makers do not care about all these kind of analyses. Because market makers analyze the markets vertically not horizontally. They have order books, which has all our trades details like take profit, stop loss. Because of these order books they did not need any other kind of information or indicator because they can influence the price movement based on order book.
Market makers are the liquidity providers in market and it is very good for trader to trade with market makers. Because when market makers are followed it will enable trader to make trades according to market makers and that will be very good for trader. Also, keep in mind that it is always advised not to trade against market makers otherwise you will lose all your assets.
You can try to find out about market makers' behavior using some indicators. Indicators will help us to verify manipulation by market makers. We can use many indicators with market maker concept. Some of them are RSI, MACD, Moving averages, Pivot Points,.....etc. I will here discuss about some of the indicators :
Relative Strenght Index is an oscillator-type indicator. RSI will tells about the trend strength and also identify when trend will end. RSI indicator has value ranged 0-100. The value of RSI tells about overbought and oversold regions in asset.
When value of RSI is 0-30, this indicates an oversold region.
When value of RSI is 30-70, this indicates a neutral region.
When value of RSI is 70-100, this indicates an overbought region.
When the value of RSI is in range 0-30 this will show an oversold region and an uptrend is expected. You can see that in the image that RSI is 0-30 and after that an uptrend started.
Similarly, when RSI is ranged 70-100 this will indicates that it is an oversold region and a downtrend is expected. You can see in picture when the RSI valued 70-100 , a downtrend is started.
In this way, we can identify trends using RSI indicator. This is all the theory of RSI indicator. Now we look at some practical works.
First we go to trading view website Link and open any chart.
Now we click on Fx option and search for RSI in search box.
- Now, we click on RSI and our indicator is applied to chart and you can see it in the bottom part of chart. You can also change the settings of indicator by clicking on settings option.
Now market maker know that Small traders use RSI indicator to find out thier trade signals. So, they try to manipulate small traders and earn from them.
Market markers always keep an eye on the oversold and overbought regions as they know small traders use them for signals. To take these regions as their opportunity they provide buy/sell pressure in these regions so that small trader get manipulated and they made their trade and soon after some time market makers convert their positions and small traders get trapped. For example, you can see in the picture below :
As you can see in the picture that the market makers try to make a selling pressure by providing liquidity and when some of the small traders are trapped they convert their positions bringing the price further higher. In this way, manipulation is done by market makers to take profit from small traders. But, we need to be aware of these traps and must try to find a good signal before initiating any trade.
This is another popular indicator among the traders. This a trend-based indicator, helps to find the trend in asset. There are two main kinds of moving averages : Simple moving average, Exponential moving average. I will not go in details of these as you can check about them anywhere on the internet.
In our case here, we need to use two moving averages one is of larger time frame and another one is of smaller time frame. When price of asset is below both the line this shows an downtrend and if the price of asset is above both the moving averages it indicates uptrend. Moving averages are also used by traders to find signal. When the smaller time frame moving average crosses larger moving in uptrend then this indicates an buy signal and when smaller time frame moving average crosses the larger timeframe moving average in downward move this shows an sell signal. These all signals and trends are shown with an example below :
In the picture above you can see the uptrend when price is above both the moving averages and a downtrend when price is below both the moving averages. Also, you can see the buy and sell signals using moving averages.
Let us now look at how to add moving averages to chart and how to change their settings.
First we go to trading view website Link and open any chart.
Now we click on Fx option and search for Moving Average in search box.
We have to click two times on the moving average indicator to add two moving averages in above step.
After adding we change the settings of moving average after clicking on settings option of indicator. And set one moving average at larger timeframe(here, 50 periods, red) and another at smaller time frame(here, 21 periods, blue).
In this way, we can add moving average indicators to our charts. Now we look at how market makers use moving averages to trap small traders.
Market makers knows that the small traders use moving average indicators for their trading so they try to manipulate the indicator using their assets.
In the example above as you can see that moving average indicator shows an sell signal. At that level, market makers knows from the order books that many traders put their stop losses at level just below the current price level. So, market makers provide liquidity to push the price in thier desired direction so that stop losses of small traders hit and they believe that this is starting of downtrend. When small traders initiated their trade in sell side , market makers now convert their positions and small traders get trapped. Hence, market makers created a selling pressure just to get small traders out of market and make profit from their stop losses.
Conclusion
In this post we learn about the market making concept. Market makers are the liquidity providers in market. They also maintains the bid-ask spread becuse of that small traders can easily trade. Market makers made profit from the spread although the spread is less but they trade in large volume so thier profit became large.
Market makers provides liquidity, higher liquidity has lower spread and lower liquidity has higher spread. Market makers put their money at risk to maintain these spread so the difference between the spreads is thier profit for putting money at risk for small traders. We also talk about the advantages and disadvantages of market makers. In the last part of article we learn how to use indicator along with the market making concept so that we avoid manipulation by market makers.
In the last, I would say market maers are very important for all kinds of markets because they provides liquidity to market and without liquidity it is hard to trade in an easy and fast way.
That's all from my article. I hope you like & learn something from this article. Thank you for reading.
Nice and detailed homework and the image that you prepared yourself are also good.
Hope you get good grading in this homework.
Thank you!