How Does Market Making Work? (discretionary)

Discussion in 'Strategy Development' started by thesniper, Jun 18, 2012.

  1. I think 90% of profitable daytraders are just market makers. They just supply liquidity without trying to outsmart the market. The daytraders that try to outsmart the market are the ones that end up losing because they fail to realize the overwhelming randomness of the market.
    The simplest definition of market making is buying at the bid with a limit order and selling at the ask with a limit order. But it can't be that simple otherwise everyone would be doing it.
    So on what basis is liquidity supplied? Tape reading? TA? Momentum? RTM? I also can't imagine averaging up or down can result in profitable market making. I thinks most successful market makers basically trade like 20 stocks all in and all out using limit orders and with the benefit of low commissions and a fast platform. And if they get too much long/short exposure they hedge with futures. Is this correct?
    Market making is as old as the markets, however I just can't find any good information in it. Please post some good books or blogs about the subject.
    It's probably a dying business (the discretionary side of it) due to automation but still want to learn how and why it works.
  2. Market makers are forced to sit on the bid and the ask at all time. So they're always averaging up/down to get in/out of positions.
    They can't sit on the top layer of the bid all the time instead they sit a few cents away sometimes Depending on their view of the market and current needs they'll be more aggressive on one side than the other.
    but because of the nature of what they do they tend to get executions against the tide. It's easier to sell liquidity in an uptrend than it is to buy it…
  3. "Trading & Exchanges - Market Microstructure for Practitioners" - Larry Harris; - Part IV - "Liquidity Suppliers"
  4. 2rosy


    how do bookies make money? its the same exact thing.
  5. 1245


    I'd rather be a bookie and keep the 10%. Good description though.
  6. All quotes are "smart" quotes. There is never a time a limit order is displayed without an immediate cover.

    ie. the profit on the trade is accounted for in the quote you see. You hit/lift that quote, the profit has already been booked on the MM side.

  7. newwurldmn


    plus you have license to break peoples' legs if they don't pay.
  8. 1245


    I don't understand what your trying to say. MM put themselves at risk with ever trade. They can neutralize risk by doing other trades, but don't realize Profits/Losses until the positions expire or are unwound. (Except at year end, they pay taxes based on MTM.)
  9. 1245


    Yeah, but you can only do that twice.

  10. Yeah.. the risk is they get hung on their hedge, and they have to payup.
    #10     Jul 3, 2012