Lesson 9 Market Maker and tools for Market Maker

what is the market maker?

In trading currencies, market makers function as intermediaries in sales and purchases between two parties and two currencies. For example a bank will function as a market maker when it collects sellers of the US Dollar to then sell to investors who have Euros in exchange. The value of each currency is based on the current market value.

To beat the MM you need to understand the basic objectives of their activity. Overall, the MM’s are traders and their objective is to make money. This includes strategies to trade against retails traders. The major difference between them and other traders is that they have the ability, through access to massive volumes, to move price at their will. So to make money, they aim to buy at a lower price and then sell at a higher price. They achieve this by:

1. Inducing traders to take positions.

This is achieved by using a range of price movements to ‘trick’ traders into taking a position in a given direction but then reversing it again. This

means that the MM can sell a specific currency at a certain price and then buy it back at a lower price when the retail trader feels too much pain from the currency value moving backward and wanting to sell it back again (e.g. via the stop loss)

2. Create panic and fear to induce traders to become emotional and think irrationally.

This often involves:

–        quick moves

–        spike candles

–        news releases

–        ‘inexplicable’ price behaviour.

3. Hit the Stops and Clear the Board.

This forces traders into ‘margin trouble’ and ultimately out of the game.

What Tools Does the Market Maker Have?

Even though they have a number of tools at their disposal, they do have some restrictions imposed on them from outside authorities. These include:

1. The IMF restricts their ability to move price to a general range so as to avoid a collapse of the market.
2. This is generally limited to the ADR and will involve moves of as much as 200 pips per day in most pairs.
3. They do not have unlimited equity so it is necessary for the market-makers to close positions and regain balance periodically.

The only tools they have are to be able to buy or sell currency in different volumes at different prices. By doing this strategically, they can:

1. Entice traders to take positions by providing evidence that price is or is going to move in a certain direction.
2. Appeal to the emotional side of traders by changing the character and speed of price changes.
3. Once the trap has been set, and the bait taken, cause the price to move in such a way as to cause price to move against the traders, allowing the banks to buy currency back from or sell currency back to the traders so that they are square again.
4. This means that the trader has entered the market by buying currency from the bank at a given price and exited the market by selling back to the bank at a lower price. Conversely, the bank has sold to the trader at the higher given price and bought back from the trader at the lower price.

While these price movements are used to trap traders into unfavourable positions, they are not used 24 hours a day, but will be used more at certain times. The patterns are most commonly observed in the following time periods :

1. The beginning of the season (quarterly)
2. The beginning of the week (Sun/Mon)
3. The beginning of the day
4. The beginning of the session
5. The end of the session
6. The end of day
7. The end of the week
8. The end of the season.

In addition to move price MM’s can take advantage of “sentiment” which develops as a result of news releases of varying types. Sometimes immediate price movements are designed and used to “cover-up” the MM is price movement. The rumour mill also has a role to play in generating a public expectation of price movement. It is not uncommon to see the general news being particularly pessimistic for example about a particular currency only to see the currency rise against it but usually after people have been trapped in line with the sentiment.

What Tools Do The Dealers And Brokers Have?

Brokers and dealers have mechanisms available to them for manipulating price to enable the process of taking money from traders, who are also their clients!

Usually, trader’s transactions are dealt with ‘in house’ and never make it to the interbank market so it is very easy for them to manipulate price to their own advantage. They have a number of additional tools at their disposal and include:

1. Requoting
2. Trigger all stops in a given price range (which is part of the dealers functions in the MT4 platform)
3. Vary the spread (which is why scalping methods often fail) at times when it is an advantage to them to do so.
4. Throw a price spike to take stops out, bear in mind that they know where the stops are.
5. Target traders who are in margin trouble and move price against their positions to “finish them off”. Again bear in mind that they know who is in trouble because it is part of their backend platform.

Chart Observations

Anatomy Of The Asian Range Stop Hunt

During a stop hunt it is normal to expect that the reversal will occur somewhere between 25 and 50 pips higher than the Asian range. It is also normal to expect that this will entail a journey of 3 pushes or candles to get there. However, it is not that simple and the 3 pushes may occur in increments of different sizes. It is important to remember this when assessing the movement as it escapes the Asian range and to not simply expect a straight 3 candle movement.

For example, the 1st push or candle may be a full 25 pips. At this point price may be held for 3 or 4 candles taking a full hour. At this point it is pushed up another 20 pip making a total of 45 pips from the top of the Asian range and finally another 5 to 7 pip on top of that. The effect of each these moves as follows:

1. Range traders who have taken short positions at the top of the Asian range will have a stoploss somewhere between 25 and 50 pips from this point. Therefore the initial 25 pip push will take-out the 1st of the stops.
2. The 1st upward movement will begin to entice traders to take long positions on the basis of a breakout trade.
3. This is accentuated by the following period of consolidation where price is being held and traders will be expecting a continuation pattern to develop.
4. It is further accentuated with the next 20 pip push further enticing long positions as price has now been rising for an hour and a half.
5. The last 5 to 7 pip is about taking the last of the 50 pip stop loss’s from the range traders. The last move is almost always just a tap, identified as a pin. The main reason for this is that it costs money to move the market and this is a cheaper option for the MM.