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 Market Making Strategy For Market Maker: A Guide

A market-making strategy involves buying & selling assets to facilitate liquidity. Learn how market maker earn profit & influence trading conditions.

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In the financial markets, traders can easily open or close buying or selling positions in different assets. Every time a trader wants to buy an asset, the other party is ready to sell it. 

Have you ever thought about who ensures this ease of buying and selling in the market? The answer is market maker.

Market makers are the individuals or institutions who continuously engage in buying and selling assets. So they can earn profit from transactions and even maintain the liquidity of the asset. 

Confused? No worries. In Beirman Capital, this article will have a study on the Market Making Strategy with its key features, advantages, and limitations. So let’s get started. 

What Market-Making Strategy Is About?

A market making strategy involves simultaneously buying and selling financial assets. Under this, market maker buy an asset at the bid price, sell it at the ask price, and earn profit from the bid-ask spread. 

Many market making strategies are present in the market. With all the other strategies, the main aim is to make market a profit. However, with market making, the main aim is to generate the market for an asset, and profit is secondary. 

Let us take an example of gold trading. Suppose the bid price of XAU/USD is $2915, and the ask price is $2917. In this case, the market maker buys the pair at $2915, sells it at $2917, and makes a profit of $2. 

Market making strategy is applicable in diverse markets. market maker are present in stock, forex, indices, etf market making strategies, crypto market making strategy​, and many other markets. 

Types of Market Making Strategies

Traders can practice market-making strategies in different ways. Here are the most popular ones: 

Manual Market Making:

The strategy is quite old, and traders have been practicing it for years. Manual market making is the most traditional form, where traders manually place orders and maintain price quotes for an asset. 

Arbitrage Market Making:

Traders can find minor price differences of an asset at the same time on two different platforms. They buy an asset from one platform and sell it on another to profit from the difference.

Algo Market Making:

Algorithmic market making refers to the use of automated tools and software to buy or sell assets. It is the most popular strategy, as market-making requires quick decision-making and high-frequency trading. Manually handling all this is not that easy. Thus, traders use algo trading software to automate trading.

Delta Neutral Market Making Strategy:

Market making also involves significant risk, and many traders use the Delta Neutral approach to manage it. It is generally used in options trading, where a delta +1 indicates the price of the asset moves in the same direction, while a delta -1 indicates that the price of the asset moves in the opposite direction.  

Benefits of Market-Making Trading Strategy

Market maker are the key pillar of the financial world. The strategy works on the principle of mutual benefits. Here is how the strategy is beneficial for traders as well as the market: 

Ensuring Liquidity:

Liquidity is the most important element of trading; many institutions and individuals practice the strategy to maintain liquidity. High liquidity means stable market conditions. Thus, many traders prefer trading highly liquid assets. 

market makers engage in high-volume transactions to maintain the demand and supply for a particular asset. By continuously buying and selling, market makerscreate liquidity for an asset. 

Whenever an investor wants to buy, market makers are present to sell. Whenever an investor wants to sell, market makers are present to sell. 

Profitability:

Market makers facilitate adequate conditions for trading and earn profit in the process. There is a minor difference between an asset’s buying and selling price at the same time. As market makers simultaneously engage in trading transactions, they earn profit through bid-ask difference. 

Managing Market Volatility:

The change in the market conditions affects asset prices, giving birth to market volatility. Although volatility is essential for trading, high price swings lead to price uncertainty. 

Unexpected economic, geopolitical, and financial events cause sudden price swings and can even lead to market crashes. However, market makers can save you from that. market maker enter and plan their trades during such unexpected events, ensuring asset price stability. 

Market-making can really help manage volatility, especially in high-volatility markets like cryptocurrencies. Many traders use a crypto market-making strategy to maintain price stability. 

Order Flow Management:

The financial market functions based on demand and supply dynamics. When more traders place buy orders, the price of financial assets increases; when more traders place sell orders, it decreases. 

Market makers keep a watch on order flow, adjust bids-ask prices, and place trades accordingly. They play a key role in managing market inefficiencies by establishing fair pricing. 

Market Making Strategy

Automation:

Practicing market-making strategy has become relatively easy in the present time due to the introduction of different tools. With AI integration, market makers can engage in high-volume transactions, execute and handle multiple trades, and undertake risk management. 

Data analysis is the core of this strategy. market makers need to watch large price data to maintain the price liquidity. Al tools can even assist market makers in the data analysis process and provide a clear picture of the market.

Limitations of Market-Making Strategy

With all the above benefits, a market-making strategy even has some limitations. So, if you are thinking of starting using it, have a look at its drawbacks: 

Complexity:

Market-making is an advanced strategy that requires an in-depth understanding of the market. Traders need to monitor supply and demand dynamics and overall trading conditions to make market trading decisions accordingly.

In addition, the knowledge of algorithmic trading tools is essential. Otherwise, practicing the strategy becomes far more difficult for a trader. 

Not Ideal for Beginners:

Many people think market makers are only for big market participants or institutions. But that’s not true; even retail traders can use this strategy to provide liquidity in the market.

However, the strategy involves high-frequency trading and quick decision-making. Also, significant capital, in-depth market knowledge, and experience are required. So, the strategy may not be suitable for a beginner with a lack of market understanding and little capital. 

High Competition:

In the trading world, the more competition, the better the market conditions. However, with a market-making strategy, competition can affect your profit. High competition reduces the difference between the bid and ask price, ultimately leading to low profit. Especially if you are a retail trader competing with big market players, survival becomes difficult. 

Bottom Line

Market making is a complex yet profitable strategy. CFDS and ETF market-making strategies can give you a good profit. However, not every trader can follow this trading style. 

Impeccable market understanding, robust automated tools, significant capital, quick decision-making skills, and an excellent risk management plan are the prerequisites to pursue this strategy. 

FAQs

What are the common market-making strategies?

  • Manual Market Making

  • Arbitrage Market Making

  • Algo Market Making

  • Delta Neutral Market-Making Strategy

What is the market-making technique?

A market-making strategy involves simultaneously buying and selling to create liquidity for an asset and earn profits.

What is the market-making HFT strategy?

High-frequency market trading is opening and closing multiple trade positions to maintain the asset market and earn profit from short-term price movements. 

What are the examples of common markets?

Common Financial Markets include forex, stock, cryptocurrencies, stock, indices, and commodity markets.