Question 1 - Define the concept of Market Making in your own words
When it comes to trading any asset or cryptocurrency asset, market making is a very important concept. Market making is basically the activity of buyers and sellers (usually by large investors and traders in the market) in the market in which buyers and sellers provide liquidity in the market. Trading can only occur where there are buyers and sellers in the market. When a user wants to buy a cryptocurrency asset or sell a cryptocurrency asset, the user would go to an exchange to buy or sell the cryptocurrency asset. The crypto exchange serves as a place where buyers and sellers meet to buy or sell their cryptocurrency assets. The price is greatly determined by supply and demand. If the demand is high, the price increases and if the supply is low, the price decreases.
This is represented on the Bid-Ask spread. The “Bid” is simply the price to buy and the “Ask” is simply the price to sell. If there are limited buyers or sellers in the market, then it might not be possible for trading to happen for that particular crypto asset and this makes the crypto asset on the exchange illiquid which means that there isn’t enough liquidity for that crypto asset. Also if there is enough buyers and sellers in the market, then it becomes easy for trading to happen and this means that there is enough liquidity in the market. In order for there to be liquidity in the market, there have to be continuous buyers and sellers providing the bid-ask spread in the market. Hence, these buyers and sellers are responsible for market making.
Question 2 - Explain the psychology behind Market Maker
The main psychology behind market makers is to buy low and sell high in the market and as a result, liquidity is provided. Buyers in the market always want to buy low and sellers in the market always want to sell high. This is represented in the Bid-Ask spread on the exchange. More liquidity in the market which basically means more buyers and sellers in the market, favors the market markets as they make profits. However, because maker makers usually the large investors and traders, it becomes possible for manipulation to happen in the market.
The market makers aims to buy at low prices and sell at high prices. The psychology of the marker maker can be further expanded using the Wyckoff's "Composite Man” theory. The Composite Man who can also be called the market maker carefully and strategically plans and executes his activities in the market in order to make more profits in the market. This activities of the market makers leads to accumulation and distribution in the market. The market makers do this accumulating at low prices and distributing at low prices.
The market makers can manipulate the order book by creating bid-ask spread in such a way that they can accumulate enough assets at low prices and sell at high prices. The Market Makers create the Bid-Ask spread by placing limit orders at prices that they want to make market in. They place buy orders at lower prices than the best buy order and also place a sell orders at the best sell order. This activity by the market makers creates liquidity in the market. Other investors and traders buy or sell at these prices set by the market makers, causing the market markers to make profit. On the MATIC/USDT pair on the order book, we can see the Bid-Ask spread.
Screenshot from Okex Exchange
Question 3 - Explain the benefits of Market Maker Concept?
Provision of Liquidity
Marker makers are responsible for providing liquidity in the market. They do this by creating the Bid-Ask spread which is essential for trading. The liquidity created by marker markers makes it possible to buy and sell assets in the market which is what trading is all about.
Ensure healthy buy-ask spread
The Buy-Ask spread is very important as far as trading is concerned. It is what ensures that trading activities happens smoothly end easily. With market makers providing the liquidity and ensuring a healthy buy-ask spread, traders can buy and sell without drastically affecting the price in the market.
Helps to increase the trading activities in the market
This is another benefit of the market makers. They help increase the trading activities in the market due to high liquidity. The more buyers and sellers in the market, the healthier the market is which is great for all parties.
Favorable environment for small investors and traders
The presence of high liquidity and enough buyers and sellers in the market, small investors and traders who have little capital can also have good time in the market because they can purchase the desired amount of asset with the little capital and also sell their acquired assists at a desired amount easily.
Reducing the rate of price slippage
Price slippage happens due to quick change in price between the time a market trade is place and the time the market trade was executed. This is mostly caused by low liquidity which causes high volatility in the market. Market makers helps to reduce the price slippage because of high liquidity and healthy Bid-Ask spread.
Quick trade execution
Because of enough liquidity and healthy balance of buyers and sellers in the market, it makes it possible for traders to quickly execute trades at a desired price using the market order type.
Question 4 - Explain the disadvantages of Market Maker Concept?
Manipulation in the market
Marker makers have the capability to manipulate the market and drive the market to favor them to make more profit. The market makers wants to buy at low prices and sell at high prices. This can cause them to manipulate the market. The market makers can create a bid-ask spread in such a way that they can accumulate enough assets at low prices and sell at high prices.
Risk of loss of capital
Market makers are known to have large capital and because of this they can manipulate the market. This market manipulation can loss of fund of other smaller investors and traders who fall for the manipulation of the market makers. Also, the market makers stand a risk of massive loss due to negative factors that can cause a flood of sellers dumping. The market makers who have buy order will accumulate the worthless assets leading to huge loss of capital.
Can cause an unhealthy trading environment
We all know that market makers have huge capitals and are responsible for providing liquidity in the market. Because of this, they have the control of removing liquidity in the market. Market makers removing liquidity in the market can lead to unhealthy trading environment for traders.
Can cause decreased value of asset
The value of an asset in the market is greatly tied on the activities of the market makers. The value of the asset can be greatly decreased if the market makers decide to pull out their liquidity from the market. This can lead to more sellers in the market, causing the price to decrease.
Question 5 - Explain any two indicators that are used in the Market Maker Concept and explore them through charts.
The RSI indicator
The RSI indicator is a very powerful technical indicator that indicates overbought and oversold in the market. The RSI indicator has an oscillator line that moves between the values of 0 and 100. The main values of the RSI indicator are 30 and 70. When the RSI line moves above 70, it is an indication that the market is in overbought. When the RSI line moves below 30 value, it is an indication that the market is in oversold. When the RSI line ranges around 50, it is an indication that there is no strong trend direction in the market and that the market is in a state of indecision.
The RSI is a very common indicator that is used by a lot of investors and trader. This is why the RSI indicator is one of the indicators that is used in the market maker concept. Market makers know that a lot of investors and traders make use of the RSI as their trading strategy for buy and sell signals, so they capitalize on this by manipulating the market and causing an increase in the buy volume in the market. This causes an increase in price. This upward price movement will reflect on the RSI as a bullish signal. A lot of inexperienced investors and traders might fall for this and place buy trades in anticipation of a continuous upward price movement. Also, traders who placed a sell trade might get their stoploss level triggered. As a result of this, the market makers makes profits.
Moving Averages indicator
The moving average indicator is without a doubt one of the most popular technical indicators that is used by a lot of investors and traders for signals in the market. What the moving average does is that is smoothens out the price fluctuations on the chart, to make it easier to filter out noise in the market. As a very common and popular indicator, a lot of traders make use of the moving average indicator for signals.
The combination of 2 moving average indicators with different period lengths mostly high period length and small period length are used by traders for identification of signals in the market. For instance, the combination of the 50 and 200 period moving average can be used for buy and sell signals. When the smaller period MA line comes from below and crosses above the higher period moving average line, it can be a buy signal for a potential upward price movement. When the smaller period MA comes from above and crosses below the higher period MA, it can be a sell signal for a potential downward price movement.
Because of the popularity of the moving average indicator in the world of trading, Market makers can capitalize on this to their advantage. especially against the short term traders and short timeframe traders. They can strategically initiate buy orders to cause a rise in the buy volume. This can cause the moving average indicator to show signals that are false. A lot of inexperienced traders and investors can make use of this false signals to perform trading activities that would lead to loss and in turn bring profits to the market makers. From the chart, we can see that the golden cross was formed but the price reversed downwards and continued to fall. short timeframe traders can make use of this signal as an early signal for an uptrend movement, but it didn't happen as the price quickly reversed downwards and continued to fall. This leads to loses and at the same time, profits for the market makers.
When it comes to trading, market makers is a very important concept. Market making is basically the activity of buyers and sellers in the market in which buyers and sellers provide liquidity in the market. Trading can only occur where there are buyers and sellers in the market. Market makers are basically the ones responsible for creating liquidity in the market to facilitate trading activities. However, even though market makers are important in the market, there are downsides to it. Because maker makers usually the large investors and traders, it becomes possible for manipulation to happen in the market. Nonetheless, the market maker concept is important in trading. Because of the downsides of the market maker concept, it is importsnt for traders to make use of multiple trading strategies to help reduce risk and also make the bet trading decisions.