In-depth Study of Market Maker Concept-Steemit Crypto Academy | S4W6 | Homework Post for @reddileep
Hello friends and welcome to my assignment task by professor @reddileep, In this assignment, I will talk about the basis and concept of Market Makers in the financial market. I hope you enjoy the class.
Define the concept of Market Making in your own words?
Market making is a term that describes a situation whereby a company or individual actively quotes two-sided markets in an asset, therefore delivering bids and offers (also known as asks) as well as market sizes for each.
Market makers are individuals or a group of people who purchase assets at the best bid and sell the same asset at the best offer in the present market. This allows them to profit from both sides of the financial markets.
The end result of this is that they create a market, as evidenced by the newest market's stock price. Furthermore, Market Makers perform purchase and sell operations in line with the present market scenario, however, they do not make transactions if the market is too volatile.
Market makers stand to gain a lot from the difference in the bid-ask spread by making available liquidity and depth to markets.
Furthermore, market-making firms do focus on a minute number of securities, for example, shares of companies in a specific industry.
The price difference between a company that buys a security and the (higher) price at which it sells it, is the point where the company milks its profit from.
So Depending on whether the holdings of a firm's securities are going up or down, the first thing the firm does is to adjust its purchasing and selling prices upward or downward.
For example, if a share is in high demand, the firm will raise the price of its share as it sells off some of its holdings, this act helps to reflect the increased scarcity value.
Every market maker males buy and sell prices for a specific number of shares. So assuming I were a market maker, if I receive an order from a buyer, I would instantly sell shares from my own inventory to fulfill the request.
This enables me to finish the order. Without confusion, market making is a concept that makes it more easy for traders and even investors to purchase and sell assets, which results in a smoother flow of financial markets.
if market making is not done, it's quite correct to say that, there may be few or inadequate trading and investment activities globally. In the cryptocurrency industry, quite a number of banks, not sidelining, most foreign exchange trading organizations, are all market makers.
For instance, the foreign exchange market makers trade ( buy and sell ) foreign currency to clients. So they make profit because of price differentials on such trades. Furthermore, they are also notable for providing liquidity, lowering transaction costs, and facilitating trading.
Meanwhile, market-making also happens in the stock industry, there are a group of Market makers who stand ready to trade (buy and sell stocks) listed on an exchange, for example, the New York Stock Exchange (NYSE). These people are called "third market makers".
Most stock exchanges ride on a system called a "matched bargain" or "order driven" basis.
What that means is that, when the bid price of a buyer meets a seller's offer price or vice versa, the matching system in charge of the stock exchange market decides that a deal has been executed.
In a system like this one, there may be no appointed or official market makers, but that doesn't negate the fact of their existence.
Explain the psychology behind Market Maker. (Screenshot Required)?
There's a lot of psychology behind market makers. Market Makers devise a way to make money by charging higher ask (selling) prices than bid prices (buying). The disparity between the prices is known as the 'spread.'
Furthermore, the spread rewards the market makers for the risk they assume in placing such trades, which could be movement of the price indicator against their trading position.
For instance, a market maker might acquire 1000 APPLE shares for $100 a piece (which is the ask price) and then decides to sell them to a buyer for $100.05. (the bid price).
Although the difference between the ask (buying) and bid prices (selling) is only $.05, by trading sizeable amounts of shares per day let's say millions, he is able to pocket for himself a reasonable amount of money meanwhile, doing that and reducing his risk of the price going against him.
Stop hunting is one of the physiological methods Market Makers use to force some players in the market out of positions. They do this by raising the price of an asset to a level or place where several others have set their stop-loss orders.
The screenshot above shows a sudden spike in price having the potential to make newbies place large buy orders, thinking an uptrend is about to happen immediately. Rather the trick is that it makes it possible for Market makers to make profit within a short period of time.
Thus, the triggering of many stop losses might result in considerable volatility, which can give a special opportunity for investors looking to enter a trade in this situation.
The difference that's results from the expected price of a trade and the actual price at which the trade is actually executed is referred to as slippage.
Some Banks even professional traders known AKA "Market Makers" manipulate prices in the market and trap smaller traders because it is the only way they can make large transactions at the desired price level.
When you "Stop buy" a long holder, a Sell order is immediately triggered since you are mandated to sell to get out of the transaction.
Meanwhile, a short holder can initiate a buy order when "Stop Hunting" since you will need to place a buy trade to get out of that transaction so that you can safeguard your account.
Explain the benefits of Market Maker Concept?
Market makers have a number of advantages such as they help financial markets by making sure the efficiency of their operations. This points out the importance of market-making in the financial markets. It is correct to assert that there would be very few transactions in the market if market makers were removed.
So this is a reason why market makers have always been a vital part of the market architecture. Furthermore, the influence of market makers is projected to last as long as we trade financial assets.
Let me highlight a few ways how market makers can assist with price volatility and impact costs in the future in the financial markets.
- The First is Price Volatility and Market Making
Market makers do well to aid in the reduction of volatility in price, resulting in fair asset pricing.
The disparity between the best bid and best ask, for instance, is known as the 'bid-ask spread' for any desired asset. It is quite important to understand that markets that operate with limited liquidity have a more broad bid-ask spread. Furthermore, Market makers are now moving in to fill the gaps in the bid-ask spread, by bringing liquidity to the financial markets.
The differences in price between consecutive trades carried out against a human market maker will be substantially larger than those executed carried out against an automatic market maker.
- Cost Impact of Making Market
Market makers are generally more efficient because they use programmatic execution and algorithms that interact such as a fried egg between two sandwiches, with exchange APIs.
And, as a result, good profits are generated since a solid API provides stable up-times and constant liquidity to Market Makers
Order books have grown quite bulkier as automation has made Market Making easier. In fact, large orders are executed at near to fair prices isn't that a welcome development? Thus, resulting in decreased impact costs and volatility.
- Increase in Trading Volume
The level of investment an asset will receive in the market will be determined by how liquid it is at any given time. A low-liquid asset is always characterized by a widespread, which has a major impact on the volume of orders received. The volume or amount of orders in a market with low liquidity is always low. High liquidity, on the other hand, is characterized by a larger amount of orders, which is among the major PSYCHOLOGY OF MARKET MAKER CONCEPTS. Because of the tiny spreads associated with high liquidity.
Furthermore, the advantages of a market maker are especially interesting for smaller accounts and private investors. The Market Maker offers:
One of the things Market makers offer is continuous price position during trading hours and thus enables quick entry or exit.
Another one is, fixed spreads are often guaranteed. This implies that no extensions can be forwarded to the trader, even in volatile times.
Additional offers: For instance, CFD brokers who are market makers often offer fractions of a futures contract. If you desire to trade directly on EUREX options or futures without engaging a middleman, for example, you have higher margin requirements.
Explain the disadvantages of Market Maker Concept?
Because of the nature of how Market makers operate, they may carry out trades against you thus, market makers might create a blatant conflict of interest in order execution.
Another con of Market makers is that can manipulate currency prices to run their customers' stop losses or similarly, they can prevent their trades from reaching profit targets.
Furthermore, Market makers can also adjust their currency quotes 15 to 20 pips away from the rest of the market. However, Scalping is frowned upon by many market makers. They do this by putting scalpers on "manual execution," which denotes that their orders may not be filled at the prices they initially desired.
A cost structure that is slightly more expensive on average than without a market maker. Although spreads can be significantly reduced, private consumers are frequently unable to trade directly on the stock exchange.
Customers can often be taken advantage of by a market maker who is not properly regulated, such as in crypto markets.
The price position is the responsibility of the market maker, which can be affected negatively by intentional spread widening or poor price execution/price positioning. Since CFD brokers are almost always regulated, this would not apply in this case, however, unexpected events should always be investigated.
Explain any two indicators that are used in the Market Maker Concept and explore them through charts. (Screenshot Required)
There are a number of indicators that can be used in the Market Makers concept for example
- The Stochastic indicator
- The moving average indicator
- The Bolinger band indicator
- The Stochastic indicator
The oscillator works based on the following principles:
Prices in the market chart will remain equal to or above the prior closing price during an uptrend.
Furthermore, during a downtrend, the prices will most likely remain equal to or below the prior closing price.
The screenshot below depicts the overbought price which triggered a bearish trend almost immediately.
In addition, when the market is overbought or oversold, the Stochastic technical indicator notifies us through its movements.
The Stochastic is a number that ranges from 0 to 100.
Anytime the Stochastic lines are above the number 80 (as you can see the red line in the chart above), then it denotes the market is overbought.
Furthermore, when the Stochastic indicator lines are below 20 (the blue line), then it denotes that the market is possibly oversold.
The screenshot below shows the price chart with the Stochastic indicator applied, depicting the oversold region
As we know, we enter the buy order when the market is oversold, and we enter the sell order when the market is possibly overbought. So the Stochastic indicator can be used in a variety of ways by forex traders.
However, the fundamental objective of the Stochastic indicator is to show traders where the market may be overbought or oversold. That's a good one.
Note that Stochastic can remain above 80 or below 20 for a protracted period of time, so just because the indicator shows "overbought" doesn't mean you should sell right away! Be careful.
- The moving average indicator
The moving average (MA) is a straight-to-the-point tool that can be used in technical analysis, it smooths out the price data by making a calculation of the average prices that is constantly updated.
The average is calculated over a selected portion of time, such as 5 days, 20 minutes, 20 weeks, or any other time period selected by the trader.
On a price chart, if you study the moving average, it can assist you by reducing the amount of "noise."
To obtain a general notion of which direction the price is trending. The white line is the 21 MMA and the yellow is the 55 MMA. As these indicators meet and cross, the direction they assume indicates the direction of the trend.
Observe the direction of the moving average. If it's slanted upwards, the price is rising (or was recent); if it's angled downwards, the price is falling; if it's angled in a sideways direction, the price is most likely in a range.
3 . The Bolinger Bands Indicator
Bollinger Bands are a technical indicator that was created by John Bollinger. It is used to determine market volatility and identify "overbought" or "oversold" scenarios in the market.
Principally, this handy gadget tells us if the market is quiet or if it's LOUD!
The bands of the indicator constrict when the market is quiet and expand when the market gets LOUD.
Take a look at the screenshot below. The Bollinger Bands (BB) are a chart overlay indicator, which means they appear above the price.
Another aspect of this indicator is the Bolinger bounce
Bollinger Bands have a tendency to return to the middle of the bands, which we are aware of.
The "Bollinger Bounce" is based on this concept.
Based on the screenshot below, we can assume the next direction of the price direction. The next direction after the candles hit the boundary of the indicator is towards the middle.
As you can see the prices dropped down from the top to the middle of the bands. And from the lowest band back to the middle again.
Furthermore, The "Bollinger Squeeze" is another concept for this indicator. When the bands squeeze together, it usually indicates that a break is on the way.
If the Candlesticks begin to break out above the TOP band, the trend is likely to continue upward as depicted in the screenshot below:
Similarly, if the candles begin to break out below the BOTTOM band, the price is likely to continue to fall. Pretty simple to understand and interpret.
Other indicators that could be used as well are Pivot, Trader Dynamic Index (TDI), Vortex indicator, and so on.
Traders should be very conversant with the mind games Market makers play. Being a trader that is easily shaken by any slight reversal in trend is risky, and market makers can fix in large sell orders, therefore, making the trend seems bearish meanwhile, traders who don't understand this concept may push all in and to their greatest dismay, the trend will reverse. Furthermore, having good knowledge of some of the indicators listed above will go a long way in reducing your risks.
Special thanks to Professor @reddileep