Market Makers’ Role In The Markets

Market Markers generally match up and process buy and sell orders from traders worldwide. It’s the market makers that create the market and in order for them to accomplish this they must have large blocks of stocks to trade with.

Market makers will look to other market makers for assistance if they don’t have sufficient quantities on their books to trade at the current price level. Or, they will have to move quickly to another price level where they do have a holding.

All market makers are in competition with each other for your business. Their response to your buy or sell order has to be realistic and responsive to market conditions.

Are Market Makers Generous?

The market is in a bull move and you place a buy order and receive what appears to be a good price from the exchange. You need to ask the question of why you received a good price. Are the market makers feeling generous in giving away a portion of their profits?

You need to understand that despite the good price you received in the up-move of the market, they are deciding to switch positions and are now taking a bearish view. Their books are now showing large sell orders to dispose of.

Their perceived value in the market is lower than yours. They expect the price to fall or at best move sideways. This action repeated many times will tend to keep the spread narrow. This limits the upper end of the price spread. They are not only giving you a good price but also every other buyer.

Market makers that are bullish and do not have large sell orders on their books, will mark up the price on your buy order. This gives you what appears to be a poor price. This repeated many times makes the spread wider as the price is constantly marked up during the day.

So by observing the spread of the bar, we can read the market makers’ sentiments and the opinion of those that can see both sides of the market.

Poorly Conceived Trades, The Market Makers Goal

It’s the mission of the market makers to suck you into poorly conceived trades. How do they do this? One way is when the market gaps up on weakness. The gap in price is different to a widespread up. The market makers are marking the prices up against the buying which is executed rapidly.

This manoeuvre is performed early on in the trading day and will have an emotional impact. This price action is to lure you into a potentially weak market. They take out stop losses on the short side and force panicking traders to do the wrong thing.

A gap in price is usually into fresh new high ground. With the positive news and a strong move, the bull market looks as if it will last forever.

Traders Are Locked Out of the Markets

In strong markets, you’ll also see gapping up in price. In this scenario, you will see a trading range to the left. Traders trapped within the trading range will become demoralized by the lack of profit. The locked-in traders what to try and get out of their trade with minimal losses. Market makers know this. To encourage the locked-in traders not to sell they will very rapidly mark the prices up through resistance areas.

market makers manouvre to lock traders out of the market.
Locked-in Traders (Courtesy of TradeGuider)

The market makers’ view is bullish and we know this because there is an increase in volume which is substantially backing the up-move. Widespread up bars lock traders out of the markets and do not suck them into a trade. It’s human nature not to buy something today that is a higher price, whereas yesterday they could have purchased it at a lower price.

Also, this panicked traders that when short from within the trading range, usually trading short on negative news, these traders have to cover their shorts (buying), which ultimately adds to the demand.

The increased volume on the above chart is a healthy increase. What we don’t want to see is excessive volume, as this is a very good sign that there is supply in the market. Low volume up bars warns you of a trap up-move which is also a sign of a lack of demand in the market.

Ninjatrader Event with TradeGuider

Gavin Holmes joined Tom Schneider from NinjaTrader as they hosted their regular Trader’s Workshop event.

Tom and Gavin discussed several key trading setups that I was monitoring, looking for some great trading opportunities.

Now 3 days later those setups are progressing exactly as Gavin predicted.

Happy Trading