The foreign exchange market (forex or FX) is a decentralized global market. Forex trading or market maker does not take place on an exchange and there is no physical address for doing business.
Unlike stocks traded through global exchanges such as the New York Stock Exchange or the London Stock Exchange, foreign exchange transactions occur over the counter (OTC) between buyers and sellers from all over the world.
This network of market participants is not centralized. Thus, the exchange rate of any currency pair may differ depending on each broker.
List of Contents
- What is a Market Maker?
- What is the role of Market Maker?
- How does Market Maker make Profit?
- How does Market Maker Work?
- Advantages and Disadvantages of Market Maker
What is a Market Maker?
A market maker is someone who provide the market liquidity and less stagnant. Keeping the market flow and within the price frame.
A market maker usually does three things:
- Set bid and ask prices within certain currency pairs.
- Commit to accept these prices with certain terms (leverage, spread, etc.).
- Protect traders’ orders to mitigate risks; however, there are many options to access orders.
What is the Role of Market Maker?
The main function of a market maker is to provide liquidity. They create opportunities for other market participants to buy or sell stocks, currencies, futures, and other trading instruments. A market maker transactions are an important part of all exchange trading volumes, allowing them to influence currency exchange rates.
When you want to buy or sell financial assets such as forex, gold, or cryptocurrencies. There is a high chance that you will deal with market makers.
The market maker is your trading counterparty. This means that when you want to buy, the market makers will offer a bid price. If you want to sell, the market maker will give you an ask price (or offer). As a major liquidity provider in the market, market makers will always be on the side of your trade because the market makers are your trading counterparty. They gain profit when you lose and lose when you gain.
How Does Market Maker Make Profit?
Bid and ask system are good for traders. This allows them to execute as many or as few trades as they want. For example, when you place a market order to sell 100 shares of XYZ shares, the market maker will buy the shares from you. Even if there are no buyers lining up. The opposite is functions similarly, since any stocks that market makers cannot sell immediately will help fill in subsequent sell orders.
For example, a market maker may be willing to buy XYZ shares from you for $100 per share, which is the offer price. Then the market makers may decide to set a spread of $0.05 and sell at $100.05 which is the asking price.
The difference between the bid price and the ask price is $0.05 but the average daily trading volume for XYZ could be more than 6 million shares. If a single market maker covered all those trades and subtracted $0.05 each. They will earn more than $300,000 every day.
How Does Market Maker Work?
The exchange rate set by the market makers are based on their own best interests on paper. The way they profit the company through their marketing activities is through the spread they charge their clients. Spread is the difference between the bid price and the ask price. The spread is set by each market makers, usually, the spread is quite reasonable due to the intense competition between many market makers. As a counterparty, many will try to hedge or close your order by passing it on to someone else. There are also times when market makers may decide to hold orders and trade with you.
Advantages and Disadvantages of Market Maker
Advantages:
- Most trading platforms include free charting software and news feeds.
- Market makers provide better user-friendly trading systems in some cases.
- Currency price fluctuations are less volatile than those quoted on ECNs; however this might be a disadvantage for scalpers.
Disadvantages:
- Market makers may trade against you, resulting in a blatant conflict of interest in order execution.
- Market makers may influence currency prices to making running their customers’ stops or preventing their trades from reaching profit targets. Market makers may also adjust their currency quotes 10 to 15 pips away from the rest of the market.
- When news is released, there is a lot of room for error. During periods of significant market volatility, market makers’ quote display and order-placement systems may “freeze.”
- Scalping is frowned upon by many market makers, who often put scalpers on “manual execution,” which means their orders may not be filled at the rates they need.
As a result, I can simply conclude that the market makers are the same as or similar to the owner of forex exchange. In the stock exchange, people who want to be a market maker may need a lot of money to be able to execute these things. However, being a market maker can be tough for the regular person. To become one of quite challenging. Lastly, you should be aware that every trading market always has market makers including FX market.
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Read more: Broker
Source: Investopedia