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Hello everyone, welcome to week 6 of this season's lesson series. The lesson taught by professor @reddileep discussed the In-depth Study of Market Maker. In this post, I will be responding to the assignment given.
<center></center><center><sub>Image was designed with PowerPoint</sub></center>
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#### <center>Question 1</center>
###### Define the concept of Market Making in your own words.
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##### Market Making Concept
In finance trading, the ratio of buyers and sellers determines how liquidity flows through the market, such that for a buyer, there's should be a seller, and for a seller, there should be a buyer. This brings about a balance in the pricing (bidding and asking price) of the assets, and also a balance between the supply and demand of the asset traded.
The **concept of Market Making** refers to the ability of **market participants to create liquidity** by **inducing volume (money flow)** to either the **buying side, which increases the demand of the asset, resulting in price increase** or **selling side, which increases the supply of the asset, resulting in a price decline**. Ideally, market making is done by **investors** (mostly institutional investors, whales, hedge fund traders, etc) with **huge trading capital** (millions or billions of dollars), whose trade order execution, can pump volume into the market.
Market making is achieved by creating trade orders (limit or instant orders) with high volume to push the market in a specified direction in an attempt to favor the market maker. There is a general notion that investors with huge capital manipulate price movement to lure and trap investors with small capital, which often results in the loss of the small investor's funds. The best way for small capital-based investors to trade is trading in the same direction as the market making.
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#### <center>Question 2</center>
###### Explain the psychology behind Market Maker. (Screenshot Required)
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##### Market Maker Psychology
As previously explained, the market makers are participants that have the ability to create liquidity with their trade order because of the amount of volume they pump into the market. This is done by executing high-volume trades on either side of the market which results in price movement to the intended direction.
The **psychology** behind market making is a tricky one, aside from generating liquidity, the observed notion is that investors with huge capital manipulate that market to **lure and trap** Investors with small capital, through false price movement, that can trigger small investors to enter trades from generated signals via price action or indicator readings, before the main intended move start.
_**Consider the illustration of how market making works below:**_
Let's assume that, An investor with huge capital of **$200,000,000** wants the price of ADA to trade above **$2.150**, but the current price of ADA is **$2.100**.
<center></center><center><sub>Screenshot was taken from [Tradingview.com](https://www.tradingview.com/) </sub></center>
_**First, the investor creates and executes a short-term **sell trade order** to get better pricing and also to generate enough supply for the intended buy trade order.**_
The investor creates a sell trade order of **$50,000,000**, which will cause a short decline in price, resulting in **investors with small capital** having their **sell signals** indicated by **price action and technical indicators**. This move drives the price of ADA to **$2.07**
Small capital-based investors **execute the sell trade** which creates enough supply for the investor with huge capital.
_**Now enough supply has been created, the investor with huge capital opens a buy trade order and mitigates the sell trade order, which results in sharp market reversal**_
The investor then creates a **buy trade order** of **$100,000,000** which is a high volume inducement to the buying side of the market, this will create more demand for ADA token forcing the price to rise, depending on the volume, the price of ADA can trade up to **$2.150** and above.
Once the intended level is achieved, the investor takes profits bit by bit until the entire order is closed. This creates a supply causing a short term or long term decline of the price.
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#### <center>Question 3</center>
###### Explain the benefits of Market Maker Concept?
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#### Benefits of Market Maker Concept
There are some benefits of the market maker concept and the include the following:
##### 1- Liquidity Generation
Market makers contribute greatly to the liquidity of a given asset by injecting high trade volume (money flow) on either side of the market participants to increase and balance the ratio of supply and demand.
##### 2- Volatility of Price
The market maker concept brings about high volatile movement of price within a specified period of time, due to injected high trading volume, which brings about rapid movement of price in the corresponding direction.
##### 3- Profitability
A proper understanding of the market maker concept yields a high level of profitability for the investor, because of the high volatile movement of price during market maker trade order executions.
##### 4- Better pricing
The market maker concept provides small capital investors with a better trade entry price of an asset. Since they tend to move prices lower to create the required supply, this offers better entry prices at a discounted rate.
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#### <center>Question 4</center>
###### Explain the disadvantages of Market Maker Concept?
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#### Disadvantages of Market Maker Concept
There are some disadvantages of the market maker concept and the include the following:
##### 1- Price Manipulation
The market makers are known to be unregulated, which brings about manipulation of price movement in either direction through the injection of high volume into the market, to cater to personal interests and profits.
##### 2- Loss of Funds
The game between market makers and retail investors is unbalanced because of the difference in capital base. With a high capital base, market makers bait small capital base investors to investing in a manipulative move that results in loss of capital as their invested capital severs as either required supply or demand for the market makers.
##### 3- Price influence
Despite the market maker providing liquidity, which brings about stable bid-ask prices, they have a strong influence on price movement. If a market maker pulls a huge volume from an asset, the price of the asset gets impacted with a price reduction, as excess supply of the asset has been created.
##### 4- Liquidity manipulation
Market makers have the ability to manipulate liquidity by choosing when to provide liquidity, as their high-volume trades are needed to maintain stable pricing of the asset.
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#### <center>Question 5</center>
###### Explain any two indicators that are used in the Market Maker Concept and explore them through charts. (Screenshot Required)
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##### 1- Relative Strength Index (RSI)
The relative strength index (RSI) indicator shows overbought and oversold market conditions, where the 70% mark denote an overbought condition, in which a trend reversal is anticipated i.e from bullish to bearish movement, and the 30% mark denotes an oversold condition, after which a trend reversal is anticipated, i.e from bearish to bullish movement.
This concept is known by both market makers and retail investors, which is why market makers capitalize on the signals to create the required liquidity for their trades.
_**Consider the illustration below:**_
<center></center><center><sub>Screenshot was taken from [Tradingview.com](https://www.tradingview.com/) </sub></center>
From the **BTCUSD** chart above, the RSI indicator signaled an overbought condition, after which a bearish reversal is anticipated. Most investors wait for price action and the break below the 70% RSI mark as a valid **Sell Signal**.
As observed above, the RSI oscillating line broke below the 70% mark, with a short-term bearish move based on price action, some retail investors will execute on the generated sell signal, which will generate the required buy-side liquidity needed by the Market makers.
Market makers will capitalize on this strategy by injecting high volume to the **buy-side** causing a quick continuation of price upwards, resulting in stoploss hit and the loss of funds of the retail investors who sold the asset.
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##### 2- Exponential Moving Averages (EMA)
The exponential moving average indicator is similar to moving averages where the cross is of the shorter period line above the longer period line is seen as a bullish signal, which implies that buyers are in control of price movement, while the cross of the longer period line above the shorter period line is seen as a bearish signal, which indicates that sellers are in control of price movement.
This concept is known by both market makers and retail investors, which is why market makers capitalize on the signals to create the required liquidity for their trades.
_**Consider the illustration below:**_
<center></center><center><sub>Screenshot was taken from [Tradingview.com](https://www.tradingview.com/) </sub></center>
From the ADAUSD chart above, the EMA longer period line crossed above the shorter period line, which indicated the presence of sellers being in control of price. Most retail investors will execute after a bearish close in anticipation of a new bearish trend.
As observed above, the bearish movement was short-lived, as the price failed to break structure and reversed rapidly, making new highs above the previous levels of resistance. This is a typical example of Market Maker Concept price manipulation, where the indicator crossing was used to lure retail traders to create the required sell liquidity for the market marker buy trade.
Market makers will capitalize on this strategy by injecting high volume to the **buy-side** causing a quick continuation of price upwards, resulting in stoploss hit and the loss of funds of the retail investors who sold the asset.
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#### <center>Conclusion</center>
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The concept of Market Making refers to the ability of market participants to create liquidity by inducing volume (money flow) to either the buying side, which increases the demand of the asset, resulting in a price increase or the selling side, which increases the supply of the asset, resulting in a price decline. Market making is achieved by creating trade orders (limit or instant orders) with high volume to push the market in a specified direction in an attempt to favor the market maker.
There is a general notion that investors with huge capital manipulate price movement to lure and trap investors with small capital, which often results in the loss of the small investor's funds.
Thank you professor @reddileep for this educative and insightful lesson.
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