Greetings, am glad to be here once again. This is my homework post for professor @reddileep on indepth study of market marker concept.
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Describe the concept of market making in your own words.
In every Market, there are buyers and sellers. The concept of market marking is generally about providing liquidity in the market. A market is said to be liquid when there's high volume of buyers and traders in the market. The liquidity of the market is enabled through the ask and bid limit or instant orders provided in the market. The process is made possible by people known as market makers. This act of market making makes the market equitable and efficient.
The market makers lubricate the the buying and selling between the buyers and sellers. They make sure that at any given time, there are always people to buy and sell in the market. The market markers in their capacity are assigned to bring liquidity in the market by making easy the trade of a given asset.
These market markers consists largely of brokage houses, banks, firms involved in foreign exchange, trading firms of high frequencies etc. They own large digital assets and selling them to others in the market enables access to these assets by investors when demand is placed hence making the market liquid. These are achieved when trade orders are created by these market makers.
Explain the psychology behind market maker
The market as said earlier is controlled by market makers. They provide liquidity for the market since they hold large volumes of a given asset. Market markers profit from the market through the cuts they make from the bid-ask spread. A market maker aims to make profit while providing liquidity in the market. For example they can put a bid ask price of $200 and an ask price of $200.16. They take their profit of $0.16 when the asset is bought. They act as middle man ensuring that assets are available for buying and selling.
On the other hand, the Psychology behind the market making can be very dicey some times as some market markers tend to push the market in a definite direction which is geared towards favouring them. There are notions that these huge investors tends to manipulate the market in order to attract small investors hence trapping their funds which leads to loss of funds on the sides of the small investors.
They manipulate the market by creating false price movements even through the use of indicators. These small investors proceed to execute trades through these falsely generated signals. On the other hand, the huge investors on seeing the inflocks, push the market the other way to achieve their aims hence leaving the smaller investors at a loss of their funds.
The screenshot above is an example of the outcome of market markers manipulation. At point one, the traders comes into the market of of price rise only for it to take a sudden trunk and starts declining. It continues without stopping and at point 3 traders begin to sell for fear of further decline and we know that for every coin sold, there's someone buying it. These market makers buy off these assets and immediately pushes the market the other direction and there occurs a sudden turn of prices upwards leaving the traders stopped out and causing loss of funds
Explain the benefits of market maker concept.
The market markers bring some benefits to the market which includes:
• Liquidity
Market markers bring about liquidity in the market through the bid ask limit or instant orders they provide. This brings about the increment in the volume of assets traded in the market.
•Time saving
Because of the liquidity they bring, there's limited time spent on trade execution and there's reduced cost of trading.
•Effective service
Market makers offer effective trading services for the buying and selling of assets especially to brokage houses which are the commonest example of market makers. They make buying and selling of assets effective in the market.
•Volatility in price movement
They cause price movement within a specific time to be volatile because of the high trading volume they bring about. This brings about quick movement of price in equivalent direction.
•Profit making
Investors make profit when they understand how the concept of market making works due to the volatility in price movement when the market orders are executed.
Explain the disadvantages of market marker concept.
Whatever had advantages had disadvantages. Below are some of the disadvantages of market maker concept.
•Manipulation of prices
Market markers sometimes manipulate the movement of price of assets to their own benefit and interest which may not be favourable for small investors.
•Manipulation of market liquidity
They are tasked with the job of providing liquidity in the Market hence can choose when to or when not to make the market liquid.
•Causing funds loss
Market makers sometimes exploit low capital investors through the manipulations which lead to loss of funds.
•Influencing price of assets
The Markers are known to provide liquidity for the market but they invariably influence the movement of price of assets. These market markers hold large volumes of assets and any huge pull can affect the price of an asset leading to a decline in asset price.
Explain any two indicators that are used in the market maker concept and explore them through charts (screenshot Required)
•Relative strength index (RSI)
The relative strength index is a very common indicator used by traders. It reveals when the market is oversold or overbought. The area marked 30% shows that the market is over sold and at this juncture, a reverse in trend which is usually a bullish movement from bearish is expected. The area marked 70% shows that the asset is overbought and at this juncture, a trend reversal which is usually from bullish to bearish is expected.
This is an open secret to traders hence the market makers can manipulate this signal using it to create the liquidity they want.
From the screenshot above, the indicator showed an overbought condition which was followed by a bearish trend. Investors see sell signal when there's a break below the 70% RSI mark. A bearish moved ensued as we saw and smaller investors on the sell signal execute their trade making the market markers have the liquidity they need on the buy side. The market makers manipulate this by causing high volume of trade on the buy side pushing the price further up which will result to the smaller investors loosing their sold assets.
Exponential moving average (EMA)
In exponential moving average, a bullish signal is anticipated when there's a crossing of the shorter period line above the longer period line while a bearish signal is anticipated when there's a Crossing of the longer period line above the shorter period line. The former shows that buyers are in control of the movement of price while the later shows that sellers are in control of the movement of price respectively.
The market markers also hinge on these to create liquidity in a way that will suit them since traders are aware of this.
From the chart above, we see a bearish trend when the EMA longer period line crossed above the shorter period line showing that sellers are in control of the movement of price. Smaller investors tend to execute trade after the bearish close. The market markers can manipulate this to create the sell liquidity they want and immediately cause a reverse in the trend by making the bearish movement to be short lived hence causing an immediate reversal in the trend by pushing high volume of trade on the buy side which will make the price to continue upwards resulting to loss of sold assets.
CONCLUSION
The whole idea of market making boils down to creating liquidity in the market through pushing in asset flow to the buy side to increase demand of asset hence increasing the price of assets or by causing decline in price of assets through increasing asset supply. All these are the handiwork of market makers through the trade orders they create. In as much as they provide liquidity for the market, they sometimes are said to push the market to their favour which results to loss of funds for small investors.
Thank you professor @reddileep for this eye opening lecture. It was educating.