Market making and liquidity provision for businesses
Market makers account for around 80% of forex trading volume, making them the most extensive liquidity providers. The Bank of International Settlements revealed this data in a 2022 review. The dominance of market makers in today’s world results from the many years they’ve contributed to the financial volume of different assets over the years. These parties have been intermediaries between buyers and sellers, setting bids and asking prices for currency pairs, and they are ready to buy assets at every point. These are the significant reasons anyone could enter or exit their positions as quickly as possible. Let’s look at the prevalence of these parties in the financial investment scene.
Overview and types of market makers
The relevance of liquidity in any financial market is fundamental to the functions of such investments. Frankly, it dictates the successes of day-to-day trade and the balance between profits and losses for investors. A liquid market ensures that buyers and sellers always have matching orders and fair market prices.
These factors make market makers integral to the investment space. They generate their profit through each transaction’s bid/ask spread, the difference between the highest price a buyer is ready to pay for an asset and the lowest price a seller agrees on.
Market makers involved in forex trading or other financial investments can be participants in a firm or individuals who buy and sell securities from their accounts. Firm participants are generally called institutional makers, while individuals are considered retail makers.
Institutional vs retail market makers
Institutional market makers are often the largest and most established of these investors. They operate as financial institutions or banks and have significant capital to work with. They also can trade in relatively high volumes, significantly changing the market.
In most cases, institutional makers can also be brokerage firms, offering tighter spreads, which is more profitable for traders. Their market offerings go beyond large-scale orders. They could also involve working bulky orders for mutual funds, insurance companies, and pension funds. They can do this because smaller spreads over large trades add up to high daily profits.
Conversely, retail market makers cater to smaller financial institutions or small-scale retail traders. In most cases, their spreads are wider than those of institutions, but the advantage is that they accept smaller transactions. They are responsible for servicing retail brokerage customer orders.
How do market makers contribute to investment businesses
These parties are relevant for more than just offering liquidity. Aside from bringing money into the sector, they also play crucial roles that provide stability and seamless transactions across the board. Their duties range from setting bid and ask prices to maintaining adequate equilibrium and balance in market orders and contributing to risk mitigation.
Setting bid/ask prices
One of these parties’ essentials is that they are ready to buy and sell securities at publicly quoted bids and ask prices. They constantly offer traders liquidity and are prepared to buy assets at the bid price and sell at the asking price.
Institutional market makers continually adjust these prices based on market conditions. Sometimes, they narrow them down to accommodate lesser spreads. Such decisions benefit investors by reducing transactional costs.
Improving stability
These bodies’ constant changes, and their checks and balances have helped several markets maintain price stability. They also change in response to the supply and demand of assets.
When there is an imbalance between buyers and sellers, they step in to make necessary adjustments, restore equilibrium, and maintain trading activities. Almost all highly liquid asset classes have a high influx of these market movers, and their willingness to absorb trade volumes makes a big difference for the day-to-day trader.
Risk management
Liquidity management has always been an integral part of risk management, and volume availability means traders have one less risk to deal with.
Illiquidity can lead to a rise in credit risks when investors cannot sell their assets. It could also be a causative factor of operational risks, such as loss of funds and capital. Market makers have cushioned such effects, and asset classes like foreign currencies and stocks are some of the most liquid in the financial market. Their presence in the sector makes it easy for traders to enter and exit positions swiftly, thereby preventing unnecessary losses from volatility.
Moreover, when there is uncertainty or unexpected price movements, market makers may adjust their quotes to avoid excessive price swings, which mitigates risks for investors. Although other risks are attached to market trading, these above are easily cubbed with decent market volume.
Market makers as foundations for forex business
Businesses thrive better when there is a working system, and one of those systems for the foreign exchange scene is market makers. The financial market doesn’t always have readily available buyers or sellers, but the after-effects of such situations are not felt when these parties are available to manage them. They make the necessary purchases and help businesses transact faster, making executions run seamlessly.
