What Are Market Making Strategies & Market Makers (Guide 2024)

A market maker is someone who places buy and sell limit orders on an exchange simultaneously, with the hope that someone will come along and fill their order.

They are not interested in the price of the underlying instrument but are instead acting as an intermediary between buyers and sellers.

The closest real-world example is a currency exchange desk at an airport. Their goal is to buy and sell as quickly as possible, without building up a huge inventory in any one currency.

On an electronic exchange, there are a number of market makers, all jostling to quote the best prices, much as you would have several currency desks at an airport.

Best Trading Platforms For a Market Making Strategy in October 2024:

1. Plus500
2. IG
3. AvaTrade
4. Coinrule
5. Freedom24

Review of the 5 Best Trading Platforms for Market Making Strategies in 2024

Plus500 was founded in 2008, and is considered to be a high-trust broker because not only is it regulated by top-tier bodies like the FCA in the UK and ASIC in Australia, but it is also listed on the London Stock Exchange.

Plus500 offers CFDs, 71 forex pairs and stocks. You can trade using its proprietary platform, which is available as a desktop download, a web trader and a useful, well-designed and streamlined mobile app.

Deposits and withdrawals are fast and free, and you can use a bank transfer, eWallets, and credit or debit cards to fund your account.

The minimum deposit is quite high, however, at £100.

The trading fees are about average, so there is not too much cost involved with making trades or maintaining an account at Plus500.

Plus500 does not offer access to platforms like MetaTrader, but it does have a proprietary platform called Web Trader that is simple and easy to use with a range of charting options and trading tools.

However, for those who like a lot of research in their trading apps, Web Trader and Plus500 as a whole does not provide that much detailed information.

For beginner traders, Plus500 does have a demo account where you can practice trading without risking your own capital, and the Trading Academy has a reasonable amount of educational material in the form of videos, eBooks and articles.

There is also a Traders Guide which has some further learning resources.

80% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you can afford to take the high risk of losing your money. *CFD trading via Plus500’s demo account.

IG invented spread betting in 1974 and today is the world’s leading online trading provider with more traders trusting them with their money than anyone else

IG is authorised and regulated by the FCA and provides traders access to over 18,000 markets. IG offers more 24-hour indices than any other provider, and extended hours on over 70 key US stocks 

For those who prefer to own the underlying asset, IG offers access to over 13,000 global shares and ETFs, or a wealth portfolio managed by one of their experts. 

Benefits:

• Advanced platform and charting – L2 dealer, ProRealTime and MT4
• Demo account
• Extended trading hours
• Extensive range of products
• Daily expert analysis & educational resources
• Round-the-clock customer service
• Negative balance protection for retail clients

Based on revenue (published financial statements, October 2022). 24/7 excludes the hours from 10 pm Friday to 8 am Saturday (UK time), and 20 minutes just before the weekday market opens on Sunday night. 

Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 69% of IG retail investor accounts lose money when trading spread bets and CFDs with IG. You should consider whether you understand how spread bets and CFDs work, and whether you can afford to take the high risk of losing your money.

AvaTrade, like many other reputable brokers, operates with a market-making strategy.

As a market maker, AvaTrade ensures there is ample liquidity in the markets it offers. This means that traders can buy and sell financial instruments, such as forex pairs, cryptocurrencies, commodities, and stocks, with ease, as AvaTrade is ready to execute trades on both the buy and sell side.

AvaTrade continuously quotes bid (buy) and ask (sell) prices for various financial instruments on its trading platform. These prices are derived from the interbank market and other liquidity providers, and AvaTrade adds its markup or spread to cover its costs and profit margin.

AvaTrade manages its risk exposure by hedging its clients' trades in the broader financial markets. For example, if a client buys a currency pair, AvaTrade may offset this risk by taking an opposite position in the interbank market or through other liquidity providers.

AvaTrade offers competitive spreads to its clients, which is the difference between the bid and ask prices. While AvaTrade adds a markup to the raw spreads it receives from liquidity providers, it strives to keep these spreads tight to attract traders.

CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 76% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

Fee: Free with a starter account or from $29.99 per month

With its simple, intuitive design, Coinrule is a good choice for those who are new to trading as well as more advanced traders.

Users don’t need to know any code to set their trading rules.

Coinrule is web-based and works across several cryptocurrencies as well as supporting some of the most widely-used exchanges, such as BitMex.

Freedom24 is a CySEC regulated broker that offers access to 15 major exchanges as well as more than a million trading instruments. Open to customers in Europe only, account opening is fast and simple, and customer support is available via email, live chat, and phone if you need any help.

New customers can take advantage of a 30-day commission-free trading account as well as a demo account to get used to the platform, which is simple and intuitive to use whether you are using the web trader or the mobile app. You will be able to find all your trades, check out the research and charting tools, and make decisions about when to buy and sell easily, but both the web trader and the mobile app have limited customisation options which can limit the more experienced trader.

Account fees are minimal, with no inactivity fee and no minimum deposit – but there is a €7 withdrawal fee per order fulfilled which you will need to bear in mind if you are not making use of the built in savings account.

For the beginner, there is plenty of education available – and the more experienced trader can also benefit from the research and investment recommendations from the Freedom Finance professionals.

What Is a Market Maker?

Market Makers are a financial entity, often a brokerage firm or a financial institution, that facilitates trading in financial markets by providing liquidity.

Market makers play a crucial role in ensuring smooth and efficient trading by buying and selling assets, such as stocks, currencies, cryptocurrencies and commodities, on their own account.

What Is Market Making?

Market Making is the practice of a market maker providing bids (prices at which they are willing to buy) and asks (prices at which they are willing to sell) for a particular asset. This creates a two-way market, allowing other traders to transact at these prices.

Top Market Makers are the most influential and active market makers in a particular market. They often handle a significant portion of the trading volume and play a crucial role in maintaining liquidity and price stability.

Understanding Market Makers

Two-Way Trading or a Two-Way Market refers to a market where both buying and selling orders can be executed at any given time. This is facilitated by market makers who provide bid and ask prices, ensuring that there are always opportunities to buy and sell.

Market Maker Signals are the indications provided by market makers regarding their willingness to buy or sell a particular asset. These signals include their bid and ask prices, which are essential for traders to understand the current market conditions.

Automated Market Makers (AMMs) are a type of market maker that operates using computer algorithms and smart contracts to automatically adjust prices based on supply and demand. They are commonly used in decentralized finance (DeFi) ecosystems, particularly in the context of cryptocurrencies.

List of Market Makers refers to a compilation of various market maker entities that actively participate in specific financial markets. These lists can help traders and investors identify the major players in a market.

Crypto market making strategy involves providing liquidity and facilitating trading in cryptocurrency markets. Cryptocurrency market makers operate similarly to traditional market makers but within the context of digital assets.

Market makers play a critical role in maintaining liquidity and efficiency in financial markets, ensuring that traders can easily execute transactions and that prices remain stable. Their activities contribute to the overall health of the financial ecosystem by reducing bid-ask spreads and minimizing price volatility.

One of the Market Maker Examples

Consider this:

You own 100 shares of Apple and you'd like to sell them. When you click 'sell' in your online brokerage, somebody, somewhere else in the world, has to buy those shares from you, at that exact quantity and price.

The odds of having another investor, sitting at home, who's placed an order to buy exactly 100 shares of Apple at the same time is low.

Market makers serve as a go-between.

A market maker will buy your shares from you, with the hope that they can flip them for a tiny markup to the next investor who comes along.

This difference between the buying price and the selling price is called the spread.

Market makers differ from investors in that they want to hold the shares for as little time as possible (as there's a risk the price will change), and want to trade as often as possible, to pick up those tiny spreads.

For small lots, market making for shares is done electronically.

For large blocks of shares, these are traded away from the main exchange, usually by the broker calling different market makers and trying to do deals on the phone.

Market makers will be members of an exchange. This means that instead of paying a fee per transaction, they will pay a fixed subscription and every individual trade is free.

Market makers are necessary for the proper functioning of a market, so exchanges may often incentivise market makers with rebates, inside information or better technology.

eToro is a multi-asset investment platform. The value of your investments may go up or down. Your capital is at risk.

Market Makers VS Brokers: What's the Difference?

1. Role and Function

Market Makers: Their primary role is to provide liquidity by continuously offering buy and sell prices for a specific set of securities or assets. They facilitate trading by acting as counterparties to trades and profiting from the bid-ask spread.

Brokers: Brokers act as intermediaries between buyers and sellers. They execute orders on behalf of their clients by finding the best available prices in the market. Brokers do not take a position in the trades; instead, they earn a commission or fee for their services.

2. Profit Mechanism

Market Makers: They make a profit from the difference between the bid and ask prices, known as the spread. This is the compensation for providing liquidity and taking on the risk of holding positions.

Brokers: Brokers make money through commissions, fees, or markups on the spread. They earn a fixed or percentage-based fee for facilitating trades.

3. Position Taking

Market Makers: They actively take positions by buying and selling assets to maintain liquidity in the market. This involves holding inventory.

Brokers: Brokers do not hold positions or inventory. They execute trades on behalf of clients and do not take a direct position in the assets being traded.

4. Risks and Conflicts of Interest

Market Makers: There can be potential conflicts of interest, as market makers may trade against their clients or take positions that benefit their own interests.

Brokers: Brokers aim to find the best execution for their clients and do not have a direct conflict of interest, as they do not take positions themselves.

Market Makers VS Brokers: What's the Similarities?

1. Intermediaries

Both market makers and brokers act as intermediaries in financial markets.

They play a crucial role in facilitating trading between buyers and sellers.

2. Liquidity Provision

Both entities contribute to liquidity in the market.

Market makers provide continuous bid and ask prices, while brokers connect buyers and sellers to execute trades.

3. Market Expertise

Both market makers and brokers have a deep understanding of the markets they operate in.

They need to stay informed about market conditions, trends, and news to make informed decisions.

4. Financial Market Participation

Both market makers and brokers are integral to the functioning of financial markets, ensuring that trading is efficient and accessible.

Market Makers – Limit Orders vs Market Orders

A quick primer on orders:

As a speculator, trader or investor, you would normally enter the market with a market order.

That's an order to trade a share at the best available market price at that moment.

You are referred to as a 'taker', as you take liquidity out of the market.

You do this because you think the market is mispriced and you're willing to bet you're right.

Market makers, by comparison, only use limit orders.

Limit orders specify the exact (and only) price they're willing to be filled at.

A limit order of 10 shares at $100 will sit waiting on the exchange’s limit order book until a market order comes along and takes it.

A market order tells the exchange to fill an order at the best possible price being offered in the exchange’s limit order book, right now, without waiting for a potentially better price.

An exchange matches limit orders to market orders.

Delta Neutral Strategy

Market makers are just trying to earn a tiny markup (spread) between the price at which they buy and sell shares, and want to do this trade as often as possible.

Market makers, when they have bought a bunch of shares, now have an outright risk, as, if the price moves against them while they hold it, they would be stuck with a loss.

To counteract this, market makers will seek to offload the risk in another place.

The simplest example of this would be two cryptocurrency exchanges.

Market makers would put limit orders on an exchange with low liquidity, and when those orders are filled, immediately send a market order (on the opposite side) to an exchange with higher liquidity.

So, if they bought on one exchange, they'd sell on another.

In this way, though, they'd have open positions on both exchanges, they sum to zero, and there's no outright position (gains on one exchange offset the losses on the other).

They'd then do the reverse to try and unwind their inventory.

The price the market makers would offer on the low liquidity exchange would be the cost of filling the market order on the higher liquidity exchange, plus a small profit.

In this way, a market maker picks up lots of little ‘ risk-free ' profits every time they trade.

This is easy to do on relatively new markets with low liquidity.

Early market makers can often make a killing here by charging large spreads.

Established/high liquidity markets tend to have very tight spreads by comparison.

Market makers adopting this strategy look for edges by:

• Looking for new exchanges/low liquidity exchanges
• Doing deals with exchanges, such that they get rebates (paid) to make markets
• Doing deals with exchanges, such that they get better information or order types than regular market participants
• Technology – Use of faster-than-internet microwave towers to spread markets; for example, between Chicago and London. Having price and order info before everyone else results in guaranteed profits. This falls into the category broadly known as 'high-frequency trading'.

High-Frequency Trading – The Stoikov Market Maker Strategy

This is a different market making strategy, based on a paper by Stoikov and is the basis of high-frequency market-making .

In this strategy, market makers place buy and sell orders on both sides of the book, usually 'at-the-touch' (offering the best prices to buy & sell on the whole exchange), which means that they will be filled whenever someone comes along with a market order.

This ‘at-the-touch’ strategy is sometimes called ‘joining the spread’. Instead of having a strategy of your own, you’re effectively copying what all the market makers are doing.

This market maker strategy trades as often as possible, constantly filling buy and sell orders around the market price.

The strategy assumes an approximately even distribution of buy and sell orders.

This is a simple way of saying that prices are a random walk.

When this is the case, the strategy makes money.

If the orders become lopsided, for example, there is a string of buys, which you'll tend to get when the market is trending upwards; here, the strategy loses money.

If you sit and watch order books on real exchanges (visit Bitmex for an example), you can see when the price moves quickly, liquidity suddenly vanishes as market makers widen their spreads and hedge their bets.

This strategy has what is known as a negative skew, as it makes small amounts of money most of the time and takes the occasional loss when things turn against it.

When a market maker gets a fill they wish they hadn’t (for example, in a trending market), this is called adverse selection. Market makers seek to avoid adverse selection as much as possible.

Many market makers will choose to accumulate inventory if they have an insight (for example, if a market is trending, they might set higher sell prices).

Grid Trading Strategy for Market Makers

This is an extension of the Stoikov strategy.

In this case, a market maker places limit orders throughout the book, of increasing size, around a moving average of the price, and then leaves them there.

The idea is that the price will 'walk through' the orders throughout the day, earning the spreads between buys and sells.

As the order sizes get larger with the spreads, this strategy has the martingale effect – it effectively doubles down as prices deviate from the average price.

Unlike Stoikov, as the orders are further apart, fills happen less often, but the spreads (and hence profits) are larger.

In this market making strategy, the most important thing is calculating the average price.

The best way to do this is:

• A moving average of prices
• A moving average of prices + a jump function (a function that resets the average after a sudden spike)
• The current best bid-offer price, reset periodically (as per the high-frequency algorithm described above)
• Looking at the prices on other exchanges/related instruments (sometimes called statistical arbitrage)

eToro is a multi-asset investment platform. The value of your investments may go up or down. Your capital is at risk.

Market Makers Myths

Market Makers Set Prices

It’s true that market makers quote prices for instruments, however, in most markets, market makers compete with each other and are subject to supply and demand. In this way, they only set prices in as much as a currency desk at an airport can set prices.

Market Makers and Stop Hunting

There is an idea that market makers perform an action called stop hunting , where they influence prices to a point where stops are triggered, generating a stop run (lots of executing stops, which causes the price to trend in one direction or another).

Manipulating the price in this way is not permitted on regulated markets.

Some proprietary trading market makers will run more aggressive strategies, but typically these strategies involve exploiting weaknesses in competing maker’s strategies.

Market Makers When Using Leveraged Trading Services (CFDs, Spread Betting, etc.)

Services that offer CFDs and spread bets to consumers act as market makers, but only on their own platform.

In this way, you are cut off from the competitive spreads you get on a real exchange.

These services charge substantial spreads to customers (as well as funding fees).

They offload their risk in the main market (see the delta neutral example above), so they'll make a guaranteed profit.

These CFDs and spread bets are not like trading in the real market.

My own back-of-an-envelope calculation implies you'd need to make a 30% return a year, just to offset the fees of trading with CFDs. The costs of spread bets are larger still.

There are exchange-traded CFDs, but if you are looking for this type of leverage and exposure in equities, you'd be better off using options, not CFDs or a spread bet.

Becoming a market maker involves establishing a presence in financial markets by providing liquidity and facilitating trading. Market makers play a crucial role in maintaining efficient markets by continuously offering buy and sell prices for various assets.

Here's a general guide on how to become a market maker:

Crypto Market Making Strategy in October 2024

A successful crypto market making strategy leverages the expertise of market makers to ensure liquidity and efficient trading in the cryptocurrency markets.

Market makers, also known as top market makers, play a pivotal role by creating a two-way market, consistently providing competitive bid and ask prices.

This approach, called market making, involves maintaining a balanced inventory of digital assets to facilitate quick and seamless transactions for traders.

Utilizing market maker signals and automated market makers, this strategy adapts to real-time market conditions, adjusting bid and ask prices dynamically.

By employing sophisticated algorithms and technology, market makers ensure that the trading environment remains vibrant and accessible.

This strategy encourages healthy competition and attracts a diverse list of market makers, collectively contributing to the growth and maturation of the market making crypto ecosystem.

Frequently Asked Questions

Final Thoughts

In the world of financial markets, market makers hold a pivotal role in maintaining liquidity and fostering efficient trading.

As top market makers, they stand at the forefront, engaging in the practice of market making to create a dynamic two-way market.

Through their bid and ask prices, market makers signal their commitment to facilitating trades, ensuring seamless transactions for both buyers and sellers.

In the realm of modern trading, the emergence of automated market makers has brought about a transformative shift, enabling decentralized and algorithm-driven trading through liquidity pools.

The landscape of market makers encompasses a diverse list of participants, from traditional financial institutions to innovative players in the market making crypto sphere.

In essence, market makers remain a driving force behind the constant evolution of financial markets, with their ability to adapt, provide liquidity and interpret market maker signals shaping the foundation of trading dynamics.

WikiJob does not provide tax, investment or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.