Currency Market Myths & Market Makers
The Truth About Market Makers
Contrary to popular rookie belief, Market Makers are not professional traders that your broker hires to trade against you and try to crash your account. Confusion arises for people who are new to trading because people want to know, are market makers for or against you?
Simply put, to answer this common question, Market Makers, whether individual or a firm, are actually there to help you. They are equally looking out for your best interest while simultaneously trying to take advantage of the amateurs in the market place. But the last is what every trader is trying to do. In order for you to make money, someone has to be losing money.
If you buy clothing from a retail store, you are offering/ losing money in order to gain/ win clothing. This same concept applies to any financial exchange.
If you are an amateur trader and are trading using software, robots, expert advisors and garbage signals, then Market Makers, along with every other self-respecting trader are going to be trading against you. You’re going to lose anyway; they might as well make more money off of you.
Market Making & Market Maker Myths
With that said, let’s look at what Market Makers actually are. Your brokerage, is a market maker. Market makers are dealers who specialize in securities, in order to make a market, they must be ready to buy or sell at least the minimum unit(s) of a specified security, at its publicly quoted price.
In currency exchange
Most foreign exchange trading firms are market makers, and so are many banks. The market maker sells to and buys from its clients and is compensated by means of price differentials for the service of providing liquidity, reducing transaction costs, and facilitating trade.
In stock exchange
Market makers that stand ready to buy and sell stocks listed on an exchange, such as the New York Stock Exchange (NYSE) or the (LSE) London Stock Exchange, are called “third market makers.” Most stock exchanges operate on a “matched bargain” or “order driven” basis. When a buyer’s bid price meets a seller’s offer price or vice versa, the stock exchange’s matching system decides that a deal has been executed. In such a system, there may be no designated or official market makers, but market makers nevertheless exist.
How Do Market Makers Make Money?
They make money by maintaining a difference between the price at which a market maker is willing to buy a stock (the bid price), and the price that the firm is willing to sell it (the ask price) is known as the market maker spread, or bid-ask spread. Supposing that equal amounts of buy and sell orders arrive and the price never changes, this is the amount that the market maker will gain on each round trip. Market makers also provide liquidity to their own firm’s clients, for which they also earn a commission.
Basically, market makers work directly with Liquidity providers. Liquidity providers are the large banks and prime brokers that offer the best-quoted security prices to their clients (the Market Makers).
Other broker-dealers will turn to a market maker when they want to buy or sell that particular security either for their own accounts or for a client’s account; this is more commonly known as making a market or market-making. Its name simply tells us that they are making the market for us to trade in.
A general rule of thumb is that the larger the market, the more market makers there are. The overall effect of having multiple market makers is greater liquidity in the marketplace and more competitive pricing.
Liquidity offers more activity or volatility in the marketplace, while competitive pricing typically offers the retail trader better or lower spreads. Spreads are a particular type of commission that derives from the liquidity being offered.
If your market maker offers a deep pool of liquidity, their spreads will typically be tighter, meaning less spread. Spread starts at the Liquidity Provider or (LP) level. Every transaction your market maker takes for its clients; it is being charged a smaller spread. Your market maker in-turn charges either a markup on the spread, similar to the difference in whole-sale v retail pricing, or your market maker will charge you a flat or fixed-price in commission. Fixed-pricing is more commonly seen in the stock market or with larger deposited accounts in the Forex market.
In comparison to selling goods or products, you have the manufacturer, the supplier then the actually store that sells.
- On a bigger level, the manufacturers actually make the market, or product, but for the supplier.
- In the financial trading industry, brokers are typically both the supplier and store front. They are going to order their own product then sell it to get a reduced cost and only be charged once, for the creation of the product.
Liquidity Providers are the manufacturers and brokers are both the supplier and store where you go to buy/ sell to participate in the exchange.
On another note, if your broker is unlicensed, unregulated and untrustworthy, they can, however, be participating in shameful and unethical practices. Similar to those of the previous largest Forex Broker in the world known as FXCM, who was banned from operating in the U.S. for taking positions against their clients.
Although they were fully licensed and regulated in the U.S., it goes to show, due diligence is a must. Always be on the lookout. But, you cannot trade any market without there being at least one market maker.
On a personal note, they were my broker at one point, and I tried warning the people I knew because their order execution speeds started to become slightly off and I would initially experience much larger draw down on my trades than usual. All that was, was them sending the order to other firms, that firm would then literally place trade orders in the opposite direction using that private and supposed-to-be confidential information.
This tactic really psyched out a lot of inexperienced traders who did not know or even have confidence in the new trades they placed. So they would close the trades in loss, not knowing whether it was a good trade or not.