What is a market maker?

Novice traders, once in the arena of the foreign exchange market, rarely thinks about who they are buying a particular trading asset from. Much more important for them is the quality and effectiveness of the trading platform, customer support and the reliability of the broker as a whole. The rest is usually the details. But it is precisely these details that are important, because the success of a particular transaction directly depends on who pulls the strings of financial market participants. Market makers - what are they? Let’s try to sort it out.

Literally, a “market maker” is a financial institution which “makes the market”. Of course, it’s quite difficult to imagine, but the principle of action of market makers is still quite clear - these are organizations that create and influence market sentiment.

According to the classics, market makers are financial organizations that provide liquidity in the currency, stock, spot and other financial markets. And although, for example, the Forex market is decentralized, all its participants are somehow interconnected.

It is no secret that to enter the interbank market for speculative operations, a person (or organization) will need to use the services of intermediaries. Why? Because the funds needed to place a transaction are quite huge. Hence the search for a broker, which is ready to provide a trading platform for use on loyal terms, is necessary.

The broker, in turn, turns to market makers, or liquidity providers, for help, withdrawing customer transactions to the interbank market. Thus, the brokerage company does not risk its own funds.

The work of the market maker and its main tasks

Before we start talking about the main tasks of market makers, it is worth voicing financial organizations that play the role of liquidity providers:

  • Central banks
  • Large commercial banks
  • Hedge funds
  • Multinational companies
  • Large brokerage companies
  • Private large market participants, such as major investors

In fact, anyone who has impressive funds that can significantly stir up the financial market can act as a market maker.

So, the main activity of market makers is the mediation between participants in the financial market.

The main tasks of a market maker are as follows:

  • Continuous delivery of quotes to participants in the financial market online.
  • Performing an intermediary function between buyers of a trading asset and its sellers.
  • Analysis of all the available price options on the market for a specific asset and the selection of the most suitable for the transaction.
  • Accumulation of placed orders for a specific trading asset.
  • Fixing offers in a glass of prices.
  • Fulfillment of the of brokers clients’ trading orders with whom the market maker has an agreement.

Speaking of the last point. A real market maker must sign an agreement with the exchange or a brokerage company, according to the terms of which the liquidity of a particular asset will be supported. That is why large brokers do not hide the “names” of liquidity providers with which they interact, and the more eminent they are, the more trust the broker inspires. But this is in an ideal world, of course. In fact, ordinary brokers are reluctant to disclose such information and are increasingly giving phrases of this kind: "Data is not disclosed." This is a disturbing bell, no doubt.

Now about the details of their functioning. Market makers have the responsibility to buy and sell assets on Ask and Bid orders. Moreover, the market is not always turned towards the data of market participants, but they have no choice but to place an order, because this is prescribed by agreement with a specific broker (exchange). Moreover, if there is no counter order, then the market maker must commit it at his own expense, waiting for the moment when, over time, there are market participants who want to purchase this order.

By the way, given the fact that market makers conclude agreements for the purchase or sale of foreign currency on their own funds, rumors appeared that these market participants are manipulating asset prices. The truth is only partial. The fact is that banks-market makers are the first to know about the advantage in the bear market or vice versa – bull market, because they can view current orders from customers. And having this information, they perform speculative operations in the market in the event that the volume of assets is sharply reduced. And therefore, they act as price stabilizers in the market, not allowing chaos to disperse with incredible progression.

How does a market maker make money?

The main source of “food” for the market maker is price fluctuations. The thing is that these participants in the financial market are more aware of its moods and the situation as a whole than, say, ordinary traders and therefore they have trump cards in their hands - they can more accurately predict how the price of an asset will behave: continue to move in its current direction or make a U-turn.

However, at any time on the market, market makers get their profit (the so-called dealing spread), otherwise no one would work at a loss. Even during periods of lull in the financial markets (regardless of what type of market it is in particular), earnings drip into the pocket of a market maker, albeit not in a huge amount.

Well, do not forget about hedging positions. When buying a large batch of a certain financial asset, futures for example, it will certainly open a position for sale in the spot market. Thus, as a rule, it turns out “fat” or at least the market maker goes to zero. But they certainly do not remain at a loss.

In addition to the above said, the profit of market makers is the reward they receive from the exchanges with which they have concluded an agreement. So to speak, for maintaining order in the financial market.

Interaction with market users

All participants of the financial market can be divided into two major categories: market makers, about which we actually talk now about market users.

So, if everything is more or less clear with market makers, as we grasped earlier - these are large financial organizations that have committed themselves to ensure the liquidity of trading assets, we did not say anything about market users.

Market users are also financial institutions, but smaller ones that actually send requests for the value of currencies and other assets in the markets. Thus, these are all other market participants.

If we talk about the process of interaction between these two categories of market participants in a more simplified way, the situation is as follows: market makers set quotes for smaller organizations (banks, brokers), while they, as market users, accept them or reject them. Thus, market makers quote the price - make price, and market users take the price or reject the price.

The largest global market makers

According to Reuters, one of the world's largest international financial news agencies, the Top 10 largest forex market makers are:

  • Deutsche Bank is the largest conglomerate located in Germany.
  • UBS - a large conglomerate from Switzerland, providing financial services everywhere.
  • Citi is one of the leading companies whose business is to provide financial services worldwide.
  • Royal Bank of Scotland - a private bank in Scotland.
  • Barclays Capital is one of the largest financial conglomerates in the UK.
  • Bank of America - the largest banking holding company in the United States.
  • HSBC - an organization that provides banking and other financial services worldwide with its head office in London.
  • Goldman Sachs is a commercial bank, a part of the Dow Jones Industrial Index.
  • JP Morgan - the oldest financial conglomerate in the world.
  • Morgan Stanley - a large American bank, previously had the status of commercial bank, and now it’s an investment bank.

Note that each market has its own major market makers and each brokerage company has (or at least should have) an agreement to interact with specific market makers. The above large organizations also include the following: Mizuho Bank, PBS, Citi Bank, Chase Manhattan Bank, Union Bank of Switzerland and a range of others.

In general, much depends on a particular trading asset. For example, when working with a currency pair, which includes the Pound, the Barclays Capital is the largest market maker. Whereas when working with a USD/CHF pair, the major financial banks not only from the USA, but also from Switzerland, namely, Credit Suisse Bank and Union Bank, are the market makers.

Author: Kate Solano, Forex-Ratings.com
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