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For performing this function, a market maker gets compensated by a markup to the bid and ask price. The difference between the bid and ask price, known as spread, is the profit a market maker generates for his role in providing liquidity. The price quoted by a market maker is based purely on the demand and supply mechanism. A market maker has no intention to predict the direction of price movement or push the market towards any particular direction through accumulation of positions.
They just facilitate an instantaneous transaction at the quoted price, without the need to wait for a counter-party. By doing so, a market maker ensures a smooth flow of price movement. In a range-bound market, a market maker will have plenty of time to cover his trades by passing on the risk to another trader who may have an opposite view about the trend. However, it will not be the case in a volatile market. Thus, to mitigate the risk, a market maker will employ several methods, including hedging with one or more tier 1 broker.
In case of a retail trader, a Forex broker will be the market maker. Unless a retail trader has opened an ECN account, a Forex broker will be the counter party to all the transactions. When a trade takes place between two banks or a bank and a large financial institution, the market maker will be another bank or a financial institution. Due to a huge competition among banks and retail Forex brokers to acquire clients who trade large volumes, the spread is extremely low and does not affect the performance of a retail trader significantly.
So, market makers play a vital role in providing liquidity and maintain competitive bid-ask rates in the Forex market. Ultimately, their objective is to provide liquidity and earn a profit through spread or commission. The role of a market maker is often presented in a distorted manner due to incidents of sharp spikes, which remove stop-loss orders.
With large banks, we can assume that they analyse an aggregate trading activity of their customers and possibly pass these data to other banks, but we can never know for sure. It may seem that market maker is almighty, but the fact is that most of them cannot simply reverse the price at any time; besides, there are other market makers who can prevent them from doing this. So, first things first:. Lines, channels, supports , etc. In this case, they are effective to a certain degree, but it is impossible to determine exactly whether there is any support at any particular level.
Patterns, formations, and waves. Once again, one cannot know in advance whether the price is going to interact with this pattern. However, most traders do see simple patterns, so a certain level of interaction of the price with them can be still noticeable. The list goes on, but we'll stop here. Taking into account all of the above, we can conclude that traders analyse the market horizontally.
Market makers analyse the market vertically. They have a so-called order book just like the one in the picture below , where all our Take Profits, Stop Losses and pending orders are displayed. While the Moving Average indicator signals Short, see the chart on the left, the cluster of Stop orders above the current price is clearly visible in the order book on the right.
Market maker is interested in such clusters, and, as we can see, the price responds accordingly. As we've mentioned before, market maker can't simply reverse the price. However, they can push it to the required level, move it towards the cluster of Stop Losses, or help form a pattern and "launch" it, if this is their goal, of course. In other words, a market maker acts against the market crowd, but on the other hand, they need another part of the crowd to push the price in the right direction.
Here's a picture to illustrate this:. Let's assume that a market maker wants to buy a currency and, of course, they want to do this at the best possible price. The left side of the picture above shows a pretty good cluster of Sell orders, which are our Stop Losses in this case as well. This volume of Sell orders will be sufficient to satisfy the demand of a market maker. On the other hand, we can see a cluster of buyers — they will be used as a safety cushion to prevent the price from breaking out further.
All that is left for the market maker to do is to push the price towards the cluster by placing small orders, gather all sellers in one place, and Limit orders are going to act as a support restraining any further price movement.
By the way, we use pictures showing the Order Book in our examples, but this is not exactly the order book that market makers have. However, this is a small part that is available to ordinary traders and is well-suited for the examples provided in this article.
If you are unfamiliar with the concept of the order book, read this article "How to Trade Order Book".
Under the Elliott Wave Principle, every market decision is both produced by meaningful information and produces meaningful information. Each transaction, while. Transparent Forex Trader and Highly Recommended Bitcoin Expert with good reputation and who happens to enter the mouths of thousands of investors due to his. Short sellers like everybody else in the market take their chances. Some win, some don't, but they contribute to the money supply just like any other player.