[In-depth Study of Market Maker Concept]-Steemit Crypto Academy | S4W6 | Homework Post for @reddileep
Greetings to all users and professors! I am writing this post in response to the assignment task given by professor @reddileep, I really enjoyed your class and really appreciate and am thankful to you for your work for the steemit community.
1- Define the concept of Market Making in your own words.
All financial markets works on Demand and Supply . Demand means buyers and Supply means the sellers in financial markets. This is how buyers and sellers determine the price of any assets in any financial markets. Market Maker facilitates both the buyers and sellers where they can define their own price to buy or sell any financial assets in the financial market.
In all financial markets there are two parties- Buyer and Seller. Buyers can put their own desired buy price to buy which is called BID and sellers can put their own desired sell price which is called ASK, collectively it is called Market Order . This mechanism is facilitated by Market Maker. Market Maker also provides the liquidity in the market (price) to help buyers and sellers to trade easily and efficiently and Market Makers earns commission from Spread of bids and asks price.
Market order is having 2 types:
Market Order: Any buyer or seller who bids or asks at the current market price is referred as Market Order . It is referred to immediate buying or selling at market price.
Limit Order: Any buyer or seller who bids or asks at his own desired price and not on the current market price is referred as Limit Order.
One of the Best Examples of Market Makers in financial market is Forex Brokers
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Question 2- Explain the psychology behind Market Maker. (Screenshot Required)
The 2 main psychology behind marker maker are as follows:
- Liquidity: For successful buying and selling activity there must be enough liquidity for both the parties to trade successfully. It is the most important aspect in trading and fully functioning of trading platform. Without proper liquidity it would be very difficult for any buyer or seller to buy or sell at desirable price in any financial market. Liquidity is the backbone of any trading system.
- Profit: Market makers earns a commission from their contribution of liquidity in the market. The difference between the buy and sell price is called spread and from spread liquidity providers or market makers make profit for them.
How they make money?
They buy in low price and sell in higher price or sell in high price and buy in low price. Example: One is buying a mango at $1 and selling the same mango at $1.10 . It means his buy bid is $1 and sell bid is $1.10 . So, the buyers have to buy at $1.10 which is $0.10 higher than the selling price. And sellers have to sell at $1 which is $0.10 less than the buying price. Here, Market Maker or the liquidity provider is making profit of 10% by buying and selling the same asset in low price and higher price. This is how Market Makers make profits from the Market Order Spreads.
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Here in image we can see it is a GHST/USDT crypto trading pair. The bid price is $1.690 and ask price is $1.692 and there is 0.12% of spread between bid and ask price.
3- Explain the benefits of Market Maker Concept.
The benefits of Market Maker Concept are as follows:
Liquidity: Market Makers are liquidity providers in financial markets which enhances the smooth trading experience for both buyers and sellers . When there is enough trading liquidity, the buyers and sellers can buy or sell instantly and they don't need to wait for opposite party for long time. It reduces waiting time and trades are executed instantly.
Efficient Trading Experience: Market Maker helps the platform run smoothly by providing enough liquidity and maintaining high volatility. These both features mainly helps the financial platforms to grow and engage traders with smooth trading experience. Without market marker and liquidity it will be very much difficult for traders to execute the trades instantly .
Maintains Volatility and stability: Market Makers eliminates the big gaps between the bid and asks prices to avoid high volatility in price of any financial assets. They always try to maintain the high volatility so the traders don't get high volatility issues in trading platforms. Stability is very much important in financial markets to avoid high risk for traders for better trading experience without high risk.
Profitable for Big Investors: Retail or big investors can take advantage of this Market Maker mechanism by providing liquidity into liquidity pools or different Market Maker platform for regular and passive income . Lots of big Retail investors eliminates high price gaps in market order , provides good amount of liquidity, eliminates monopoly market orders and makes the platform more suitable and accessible for traders. At the same time they also make profit by providing liquidity.
4- Explain the disadvantages of Market Maker Concept.
Disadvantages of Market Maker Concept are as follows:
Price Manipulation: Liquidity providers can manipulate the price of any assets in the financial markets by removing the liquidity from the Market Maker. Initially they can show some price rise and when other small traders enters the market, they can sell out and exit from their positions. They can withdraw liquidity at anytime which causes loss for other traders. They can shake prices by making both spreads and prices more volatile.
Monitoring and Regulation: If we talk about liquidity in cryptocurrency platforms then it is a serious issue in decentralized exchanges. Decentralized Exchanges or decentralized platforms are not regulated and we cant monitor which is genuine or not specially if any new project comes into the market. There are lots of coins or projects came in thge past and also coming into the market and they ran out of the market after scamming lots of investors and trader. They show off fake liquidity initially and when traders enters they exit by talking out their all liquidity and dumping the price .
Opposite Trades: The liquidity providers can trade opposite to the traders and their sentiments and this may lead loss for the traders because they have high amount of fund which they can use in their own way to earn profit from it . Traders can see either rise or dump in price opposite to the traders.
Risk of threats or Hacks: The liquidity pools specially cryptocurrency pools are risky because of hacks or any security related threats. In case of hack all funds locked into the liquidity pools will be lost. We should never provide liquidity into non audited pools as there is always high risk of security threats and scam.
5- Explain any two indicators that are used in the Market Maker Concept and explore them through charts. (Screenshot Required)
- I am going to explain about RSI and Stochastic oscillator indicator in market maker concept.
RSI : Relative Strength Index is the most popular indicator used by all traders to determine the price levels and possible movements by following overbought and over sold area . RSI levels are scalled from 0 to 100. level 0 to 30 is considered as oversold area and level 70 to 100 is considered as overbought area. Price keep moving in these levels (0 to 100)
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This is SOL USDT pair chart on 4 hour candle, we can see when price hits overbought area +70 levels, price reversed from that area towards downside. And again when price hit -30 levels, price reversed from this area toward upside.
Markets Makers take advantage of this trading psychology and try to move the market price towards opposite direction of the general traders. Below i am showing how they play against the retail traders:
On image we can see the RSI level is above 70 and price should reverse from that level towards downside but we can see continuous rise in price towards upside which is against the Trading psychology . General traders will open a sell trade or close their positions but the market makers are forcing the price to move up against the retail traders.
Stochastic Oscillator Indicator: It is another popular trading indicator used by wide number of traders to indentify price movements and reversals. Like RSI it is also an oscillator indicator which helps us to identify overbought and oversold areas. This Indicator's range levels are from 0 to 100. 0 to 20 is considered as oversold area and 90 to 100 is considered as overbought area.
This is SOL USDT pair chart on 4 hour candle, we can see when price hits overbought area +75 levels, price reversed from that area towards downside. And again when price hit -25 levels, price reversed from this area toward upside.
Markets Makers take advantage of this trading psychology and try to move the market price towards opposite direction of the general traders. Below i am showing how they play against the retail traders:
On image we can see the Stochastic Oscillator level is above 75 and price should reverse from that level towards downside but we can see continuous rise in price towards upside which is against the Trading psychology . General traders will open a sell trade or close their positions but the market makers are forcing the price to move up against the retail traders.
The Market Maker concept is very much important thing in financial market which all the traders should have knowledge about it. It is very much important for financial markets specially current Cryto markets where decentralized exchanges are becoming more and more popular these days.
At the same time we should be aware of Market Maker Concept Psychology and trade carefully in all kind of financial markets .
Thank you so much professor @reddileep for the amazing Market Maker Concept and Ideas related lecture.