Market Makers & Forex Trading

If you are interested in trading the market, it is important to know how they work and how to get started. As a beginner, if you do not know the types of makers and what they do, you could end up losing your money. In this article, we explain what forex trading and market makers are and how they work. 

What is forex trading?

Forex is the market for trading international currencies and the forex market is a 24-hour market that operates from Sunday to Friday. The market does not have a single central place of operation. The currencies are traded worldwide in all the major financial centers. You can trade forex via spot, futures, or forward markets but the largest of all is the spot market. A lot of forex brokers are market makers, let us see what they do.

What is a market maker?

A market maker is a financial intermediary who is ready to buy or sell assets by constantly quoting the bid and asking prices that can be easily accessed by other participants or traders on the platform. It could be an individual or an institution that engages in the buy or sell of an asset to facilitate liquidity. One can also call the market maker a liquidity provider since they help with the trade and make a profit from the bid/ask spread. In most cases, it is a large institution functioning as a market maker.

Market makers are more common in the stock market, and they can only sell the number of shares they buy themselves. They set market prices at levels that are essential for the demand and supply to find balance. If the market becomes volatile, the market maker will help bring stability to it and they will be responsible for the market performance, which means they carry a high risk on their shoulders.

Benefits of opening an account with a market maker

If you want to trade, you must consider working with a market maker. When you open an account with a market maker, you can enjoy better trades at lower risk. Market makers post a bid and ask for stock, once they do it, they have to honor that offer if you want to transact at that price. Hence, you will be a part of the reliable ecosystem of traders and can execute your trade. 

Despite the negative sentiment around the role of market makers, investors do enjoy quick, highly efficient, and low-risk trades. There are times when you get a good deal from them if the market is illiquid, the market maker will offer better spreads, high liquidity, and execution. They also do not charge commissions since they function as wholesalers, and they also have a lower minimum deposit requirement. 

Pros and cons of market makers

Let us consider the pros and cons of market makers. 

Pros 

Security availability 

Market makers act as custodians and allow investors to get exposure to the assets that would otherwise be unavailable to them. 

Investor confidence 

Market makers give confidence to the investors by confirming that the assets are worth investing in. They analyze the assets from a different perspective which also activates the barometer for the overall market. 

Seamless markets 

A market maker will play a crucial role in improving the functioning of the market by maintaining volume and liquidity. 

No commission

Market makers do not charge commissions since they work as wholesalers. This means they earn revenue through a markup on the market spread that they get from the banks or brokerages.

Cons 

Insider trading 

You will notice that there is always a chance that market makers use information that is not publicly available and engages in insider trading so as to take home illegal profits. This could lead to extreme regulatory actions while also affecting innocent investors. 

Conflict of interest

Market makers are involved as dealers and brokers which can create a conflict of interest. As brokers, they provide their clients with the best execution advice and as dealers, they become counterparties and are trading for profit. Hence, investors need to be very cautious here and then make a trade.

Impacts market integrity 

A market maker will deal with a large number of assets, and they have the potential to impact the market’s price. Due to this, the investors could also engage in herding behavior and harm the market. This is why the actions of the institutions could also damage the integrity of the capital market. 

The bottom line 

In terms of technical aspects, the role of a market maker is very complex, and it also has real value for financial exchanges and markets. Their role is indispensable and despite the drawbacks, there are also many benefits of opening an account with a market maker if you want to engage in trading. However, do your due diligence before you place a trade.