This is Season 4 Week 6 of Steemit Crypto Academy and I'm writing homework task about "In-depth Study of Market Maker Concept" assigned by Professor @reddileep

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On the market we may have two fundamental types of orders: the market orders and the future orders. In the market order we place a buy or sell order at the current price of the asset. A market order is placed almost immediately at the current price where the sell price matches the buy price and vice versa. In correspondence with the term market order such traders are called the market traders.

In the future order however an order is placed to be executed in the future at when the price of the asset touches the order price. The traders in this type of order estimate the price and place a limit order which is shown in the open orders as pending.

In the limit order the price is above or below the market price. Large financial groups, financial institutions, brokers and firms use the limit order to play with the price of an asset they are called the market makers. They do so for their own benefits to control the flow of an asset and hence its liquidity.

Their main goal is to stretch the price of an asset away from the market price. They provide liquidity and depth to the market. These types of traders make profit from the difference in the price of bid and ask prices. And it is done by defining the prices for the sell and buy orders.

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Have you noticed that when you place an order at the market price it takes a second and then is executed? The mechanism behind this process is that the price at which you place a sell order is matched with a buy order stored on the order book and that is why it may take time. The price at which the order is executed is then shown after the order has been fulfilled.

There is one other thing that the traders might have noticed: the fulfillment price sometimes differs from the price at which the order was executed. This is simply termed as the slippage. It is due to high fluctuations and volatility of the crypto market. Market makers often make use of the Bid-Ask spread to make profit.

Through their own analysis they place limit orders at prices that the market is likely to reach in the future. In doing so they define the prices for selling and buying the asset. Most of the market makers work on the behalf of financial institutions and provide liquidity to the market. They place buying limits at a lesser price and then simultaneously place a sell order at a higher price and that is how they earn profit and contribute to the liquidity.

The market takers continuously take trades between these set limits. For example a buy order is placed at 10$ which is less than the market price and the sell limit is placed at 15$ which is higher than the market price. The order will be executed once the current price reaches such limits between these orders the market takers will be selling and buying the assets at the immediate or current match making prices. This increases the liquidity of the asset being provided by the market makers.

Often large coin holders or the whales take part in the concept of market making. They in a way play with the price by placing buy and sell orders at their calculated prices. Through their huge sums they manipulate the market.

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The merits of market making concept is:

Providing liquidity:

Market makers provide liquidity by defining price limits. The market takers trade within the limits placed and hence there is a smooth flow of liquidity in the market.

Balancing the bid-ask spread:

Bid-Ask ask spread is the difference in the buying and selling quotations. The market makers by smoothening the market prices and by contributing to the liquidity they decrease the Bid-Ask spread and stabilize this spread.

Opportunities for small-scale investors:

Another result of the smooth liquidity and decreased bid-ask spread is viable opportunities for small-scale traders. If the Bid-Ask spread will be large traders with small investment won’t be able to execute and fulfill the trades as they will require large funds. In addition to that the understanding of this concept is beneficial in taking profit through the difference of Bid-Ask price.

Increase the number of orders:

Market makers place multiple buying and selling orders at different prices and hence the concept of market makers increase the number of orders on the order book this in turn create more matching opportunities and bring smoothness in the market.

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The demerits of the Market maker concepts are that big investors manipulate the market and in a way centralized the price changes of the asset. They may exit the trader earlier, trapping the small investors in the situation for the sake of profit and in this way affecting the small investors.

During this earlier withdrawal of the funds, the market may immediately get inclined to one direction and investors like us can even lose whole of our capital.

Market makers should provide for the long term by simultaneously placing multiple orders hence they should be backed by large groups. Many market makers do not follow these general guidelines and provide irregular liquidity which is not at all favorable for the market.

The first demerit can also be explained in terms of Bid-Ask spread since market makers directly affect the liquidity of the asset they can also manipulate the bid-ask prices and may thus provide the worst possible bid-ask prices.

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In this part of the post I am using a combination of two indicators for understanding the market maker concept. Indicators help us understand market movement and predict trade signals. When we use a combination of indicators it enables us to understand different aspects of the market in a better way.

For this part of the post I will be using EMA lines and RSI. These indicators will help us recognize the presence of market makers and filter false signals generated due to their entry or exit. This would help us make wise decisions regarding our trades. The EMA line will help us understand the direction of the trend and in accordance with the price action and RSI help understand the strength of the trend. It is important to understand that Market makers go  step ahead in manipulating the market in using the EMA lines as they may use them to send false signals. Using them in the chart in combination of the RSI will help us detect their presence.

The RSI is based on the market data of previous periods to indicate overbought and oversold condition of the market and indicate the relative strength of the trend. It relates the closing price of the current candle wrt to the previous candle. It filters false signals by degrading the very high very low short lived peaks. 14 periods is the best setting for RSI.  It is an ideal setting used by traders world-wide. It is because this setting provides the most moderate trade signals. It is not very thin wavy to show false signals and not very shallow to digest even the important signals.

On the charts 

Now I will be explaining the above concepts through the charts

We first of all added RSI. The upper band above which the market is in overbought condition is set to 70 and the lower band below which the market is in oversold condition is set to 30. The middle band is 50 above which the market is bullish and below which the market is in bearish trend.

In the chart above  we see that when the market was trending up the RSI gave a signal towards an overbought market condition and started moving up and crossed the 50 band to finally reach the overbought condition. The traders take the overbought condition to place the sell order once the RSI line has entered below the 70 line.

Now we will add the EMA and study the market maker concept with the help of the two indicators.

For the EMA line I am again using the most frequently used period setting that Is 50 because it provides the most accurate results.  In EMA when the price is trading above the EMA line the market is said to be in an uptrend while the price is trading below the EMA line the market is said to be in a downtrend.

In the chart below you can clearly see the price trading above the EMA line and the market is in up trend

Now if we study both indicators together we can understand whether a signal is a manipulated signal or a real signal

In the chart above we can see the price is still trading above the EMA line but RSI started showing a down trending movement indicating a downtrend. If at this time small investors would have placed sell orders they would have been affected badly this is a clear indication of the presence of market makers and how they are manipulating the indicators.

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Conclusion 

Market makers provide liquidity to the market but sometimes they can manipulate the market for their own benefit which can be hazardous for small scale investors. Using a combination of investors to  filter false signals and indicate the presence of market makers' operation is always beneficial for trading safely.

Regards

@salmanwains