Introduction
Hello Crypto Lovers,
It is another wonderful week again at the crypto Academy. I hope you had great weekend. This week is the sixth week in season 4 in this academy, and I hope this week brings blessings and favour. I am Kehinde Micheal and my username is @msquaretwins on steemit. I have gone through the lecture presented by Prof @reddileep on Market Maker Concept in the intermediate class. He has keenly explained this concept in his post. Therefore, I will be answering the questions posted in the homework section based on my understanding. Happy reading!
1. Define the concept of Market Making in your own words.
sourceIn finance trading, buy and sell order of an asset can be executed either immediately or in the future. When a sell or buy order activated almost immediately after the order is placed, the order is said to be taken at current market price and such an order is called market order. In market order, traders accept to buy or sell an asset at the current market price. In other words, traders take the price of the asset as it is at that particular time. The traders that execute order at a current market price are called market takers.
The second view an order can be placed as said above is to define price for an order. In such a case, the order would be executed in the future. When an order is taken not at the current market price, the order would not activate immediately. Instead, it would be added to the "open order" An order that is added to "open order" is a pending order that is waiting to be filled or executed in the future. This type of order is called limit order. They are the orders that are defined by traders to get filled at a price that is different from current market price. Those that set this type of orders are called market makers. Market makers provide liquidity in market with buy and sell order.
Market making is the process used by market makers to set or define the price of a crypto asset at a level different from current market price. It is one of the trading strategies used in crypto trading to make profit by providing liquidity in market. In this strategy, the price of buy and sell order of crypto asset is defined and the liquidity is provided concurrently in the market.
2. Explain the psychology behind Market Maker. (Screenshot Required)
sourceIn trading, the price at which buyers and sellers are willing to buy or sell an asset is recorded in the order book of that asset. Then, the order matching system matches the order at the fulfilment of price and the current price at which the asset is bought or sold is displayed.
As said earlier, some traders take instant execution of orders of which it is to be executed immediately. But at times, there may not be many orders in the market taken at current market price to be matched and as such, delay in execution would happen which is normally called slippage in trading. Slippage occur when a market order get filled at a price different from the price at which it was taken. And this is where market makers come into play.
sourceAs rightly said, Market markers are those that set limit order in crypto market. They set both buy and sell limit order for an asset from their trading account in a way to provide liquidity in a financial market. Market makers set a defined price for bid and ask limit order for an asset at a future price and when the price get to this place, they are immediately matched with orders that are placed at the current market price by market takers, and then the orders get filled.
For instance, if a market maker set a limit order for a buy order at $50 and also set a sell limit orser at a price slightly above the buy order let say $53.5. Then other traders try to place order at a current market price when the price reaches the prices set by market maker, the order will be matched immediately thereby helping the order that is taken at current market price to be filled instantly.
Market makers make profit from bid-ask spread of the submitted orders. If there are no market makers, trade orders will not go smoothly because they are the reason why trade operation is running smoothly. Why? Because they provide liquidity in market and this is one of the psychology behind market makers Liquidity in market means the capacity of an asset to be sold or bought at a current market value.
In short, Market makers help to provide great liquidity in market and thereby reducing price volatility in market. This in turn minimize the delay in the execution of order.
3 Explain the benefits of Market Maker Concept?
There are a lot of benefits of market maker concept in finance trading. Some of these benefits are highlighted below.
• Provide Liquidity in Market: Liquidity is the ease to buy and sell an asset at a current market value. Or ability to buy or sell an asset at any time. One of the process or ways an asset get enough liquidity in market is through market marker concepts. Market marker provide sufficient liquidity for an asset and thereby enabling instant matching of orders.
• Smooth Running of Trade : Without the concepts of market maker, there won't be smooth running of trading. This is because, anytime there are not enough market orders to be matched in market, trading activities will be paused until there are sufficient orders to match together.
• Reduction of Price Volatility and Slippage: Market marker concepts reduces price volatility which is often cause by slippage in market as a result, bid-ask spread is maximize in market.
• Increase Volume of Trading: How much investment an asset will get in market depends on how liquid it is at a particular time. An asset with low liquidity is always associated with wide spread and this has a great effect on volume of the order receive. Low liquidity market always has low volume of order. Whereas, high liquidity which is one of the greats psychology of market maker concept is associated with great volume of orders. Because high liquidity has a very small spread.
• Increase the Number of Investors: Market maker concept helps to maintain healthy bid-ask spread. This therefore provide room for more investors to invest.
4. Explain the disadvantages of Market Maker Concept?
The disadvantages of market maker concept is explained below.
• Liquidity are provided for Short Time: Market markers are not regulated by any group and as such they provide liquidity for a short period and withdraw their fund from the market.
• It may lead to Loss of Investment: Market markers get their profit by trading against retail traders or small investor. The investment of small investors can be swallowed up by market makers especially if their concepts is not properly know.
• Misconduct of Price of an Asset: Market markers can bring the amount of an asset to a value a very low price. For instance if the limit order set for a sell order by them is very high such that small investors are afraid and the response from small investor to take a buy order are very low, this may cause the price of an asset to fall.
5. Explain any two indicators that are used in the Market Maker Concept and explore them through charts. (Screenshot Required)
In finance trading, indicators are technical tools that are used for analysis of an asset which in turns help traders to make good market decision. There are many indicators that are used in the market maker concept. Some of these indicators are listed and explain below
• Stochastic Oscillator
• Moving averages
• Bollinger band
• Trader Dynamic Index (TDI)
• Vortex indicator
• Pivot Point
• Accumulation/Distribution Indicator
I will explain the first two indicator listed above.
Stochastic Oscillator
Stochastic oscillator is a popular oscillator majorly used by traders and of course used in market maker concept. This oscillator is used to determine the support and resistance level of an asset. It is used to detect the trend of an asset and also give overbought and oversold signal.
The picture above is a chart of BTCUSD and stochastic oscillator. The stochastic oscillator has two lines; % K line and % D line. These two lines moves in the direction of price. In addition to the feature of stochastic oscillator is the oversold and overbought region as indicated in the screenshot. When the two lines of stochastic oscillator cross each other at the oversold region, there may be reversal of the current trend and buy order is always envisage. And when %k line and %D line cross each other at the overbought region, the bullish trend had weaken and the bearish trend is around the corner and a sell order is always envisaged.
As seen in the picture above, the two lines of stochastic oscillator crossed each other at the overbought region as indicated by a red arrow in the screenshot above. The asset sell for a short time and then rose against the indicator in the opposite direction. The short sell is as a result of market maker trying to provide liquidity and the move market downward a little and the other retail traders think it is a sell signal having seen signal from the indicator. In a short while, and then they moved market upward again and the price rallied upward as seen in the chart.
The second indicator I want to explain is moving average
Moving average
Moving average is another great indicator that is used in market maker concept. Moving average is used to determine the trend of an asset. Traders do add two moving averages with different length to get buy or sell signal. For a bullish trend to turn to a bearish trend the two moving averages must cross each other upward down. And for an asset that is in bearish trend to turn to bullish trend the two moving averages must cross each other from downward up.
Below is a chart with moving averages indicator.
The moving average is added to the chart of BTCUSD as seen in the above. The blue line is the 20 MA and the red line is the 55MA. BTCUSD asset has been moving in a bullish trend for some time. But when it get to a point, the market maker tried to provide liquidity for sell order and the asset sold for a short time and at that point the 20MA crossed the 55 MA from the top. The retail traders then think the signal is for big sell and they sell their assets.
In a short time, as seen in the screenshot uploaded above, the market maker through their large sell liquidity then bought the asset back and the price of the asset reversed and bought against the signal provided by the moving average indicator.
Conclusion
The concept of Market making keeps the trading operation moving smoothly as it helps to provide liquidity in market. This concept also help the matching of orders to be done almost immediately thereby reducing delay that often caused by slippage in market. Furthermore, the volume of order in market is also increased tremendously as a result of presence of market makers.
Through the lecture presented by Prof. @reddileep I got to understand the concept of market maker in crypto trading. Special thanks to Prof @reddileep for this great and wonderful lecture.
Thank you for reading
Written by : @msquaretwins
CC: @reddileep