Who is the market maker and his role?
The market maker is a party that continually buys and sells currencies at quoted prices in OTC markets. Here the market makers play the role of the counterparty in most of the deals executed by individual traders.
To put it simply, when a retail trader buys a particular currency, the market makers act as the seller and vice versa. It is worth noting here that the market maker has no choice but to trade against its clients. One of the main functions that a market maker performs is to provide the liquidity needed to trade any type of asset.
Doing this role requires that the market makers receive appropriate compensation by adding a price premium to the buying and selling prices. The difference between the buying and selling prices is called the spread, which represents the profit that the market makers make in exchange for providing liquidity. The price offered by the market maker depends entirely on the mechanics of demand and supply.
Roles of the market makers
The market makers do not need to predict the future direction of price movement or push the market in a particular direction by aggregating deals, as its role is limited to facilitating trading deals at the displayed prices without having to wait for a counterparty to appear. All of these roles help ensure the smooth flow of price action.
In sideways markets, the market maker has time to cover his trades bypassing the risk on to another trader who is willing to take the opposite view of the current trend. However, this is not the case in volatile markets, and therefore the market maker resorts to employing a number of methods to reduce risk, including hedging with one or more banks.
The market maker in the Forex market
For the retail trader, the forex broker is the market maker. In other words, as long as the individual trader does not open an ECN account, the forex broker will still act as a counterparty in all trades.
Due to the huge competition between banks and forex brokers to acquire clients who trade in huge volumes, these parties charge very low spreads without affecting the efficiency of the services provided to the retail trader. Ultimately, the main objective of the market makers is to provide liquidity and to make a profit on the spread or commission.
It often happens that some talk about the role of the market makers in a distorted way, blaming them for the sharp price jumps, which often lead to hitting stop-loss levels. However, there is no denying the vital role that the market maker plays in maintaining the efficiency of financial markets, including the forex market.
Professional Trader and Analyst, economist in Financial and Forex market since 2004.holds an MBA from the American University in Egypt. Mohammed works as an economic writer and technical & fundamental analyst for many international Forex and financial trading companies in both English and Arabic on a daily basis.