The Software Powering Today’s Market Makers
The term “market maker” might sound like someone waving a wand to create a bustling bazaar out of thin air. And while there’s no actual magic involved, what market makers do is no less impressive. They are the unsung heroes of liquidity, ensuring that the buying and selling of stocks, forex, crypto assets, and derivative instruments occur smoothly. But behind these financial wizards lies something even more powerful: software.
Before that, let’s find out what market makers are and what they do.
Who are market makers?
Market makers are financial firms that facilitate the trading of assets by providing buy (bid) and sell (ask) prices. They stand ready to buy or sell these assets at the prices they quote, effectively creating liquidity in the market. Their goal is to ensure that there is always a counterparty for a trade, reducing the time it takes for transactions to be completed and stabilizing prices.
Here’s what they specifically do to fulfill their mission.
- Market makers continuously quote two prices for a given asset: the bid price (the price at which they are willing to buy) and the ask price (the price at which they are eager to sell). This dual quoting ensures that there is always a ready buyer and seller for the asset.
- When investors want to buy or sell an asset, they can do so immediately at the market maker’s quoted prices. The market maker will either sell from their inventory or buy the asset to add it to their inventory. This immediate execution of trades prevents delays and ensures that the market remains active.
- Market makers hold an inventory of assets they buy and sell throughout the trading day. They carefully manage this inventory to minimize risk and maximize profits, often using sophisticated algorithms to adjust their quotes in real-time based on market conditions.
- The difference between the bid and ask prices is known as the spread. Market makers earn a profit by capturing this spread on each trade. For example, if a market maker sells a stock for $100 and buys it for $99.50, then they have immediately captured a $ 0.50 profit per share traded. This also means that for any party buying that stock from the market maker at $100, the price has to rise by $0.50 just for the position to break even.
How are market makers different from liquidity providers?
Liquidity providers are akin to wholesalers who supply goods to the market but aren’t always present at the stall. They bring depth to the market by ensuring a healthy supply of assets available for trade, but they don’t necessarily stick around all day to quote prices. They might swoop in when the time is right, adding their assets to the mix, but they don’t have to quote prices 24/7 like their market-maker cousins.
In contrast, market makers have a regulatory obligation to provide two-sided quotes in the interests of liquidity and market stability, meaning they’re required to quote both bid and ask prices to the market. Additionally, depending on the jurisdiction, they may be required to adhere to a maximum bid-ask spread.
Liquidity providers have no such obligations; their role primarily involves supplying assets to the market, enabling other institutional participants to create markets with those assets. Liquidity providers are among the largest institutions in financial markets, typically international banks and other funds. These institutions hold massive inventories of financial assets.
Market makers, on the other hand, are market specialists who take more risk by performing market-making activities with their own capital. So, while every market maker is a liquidity provider, not every liquidity provider is a market maker. Market makers don’t perform their magic manually; they utilize specialized software. Read on to find out more about market-making software.
What does market-making software do?
At its core, market-making software is all about automation. Gone are the days of traders shouting orders on the exchange floor (although let’s be honest, the Wall Street drama was fun to watch). Today, algorithms handle most of the heavy lifting. These programs continually monitor the market, adjusting prices and orders to ensure efficient movement.
Imagine trying to juggle ten balls while walking a tightrope—and the balls are on fire. That’s what market makers do, except they have software that makes it look easy. This software uses complex algorithms to predict price movements, place orders, and manage risk, all in the blink of an eye. It’s like having a team of financial Einsteins working around the clock, minus the coffee breaks.
Here’s a breakdown of the critical software components market makers typically need:
- A trading platform allows market makers to place and manage orders, execute trades, and interact with exchanges.
A good fit from the Devexperts product line is DXtrade, a trading platform tailored for firms working with a variety of asset classes and instruments. It features high-speed order execution, enabling market makers to place and execute orders within milliseconds. DXtrade supports multiple asset classes and derivative instruments, including stocks, bonds, mutual funds and ETFs, currencies, futures and options, crypto assets, and more.
Another important thing is that DXtrade features a comprehensive range of risk management tools to manage exposure and ensure compliance with risk limits.
- Market data feeds
Our subsidiary market data provider, dxFeed, enables market makers to rely on institutional-grade, real-time, and historical data to make informed trading decisions and accurately price assets.
- An order management system (OMS)
Order management systems help market makers manage and route orders to exchanges and trading venues. DXtrade’s OMS offers real-time management of orders, positions, account balances, and fractional and notional trading capabilities. Our ebook about fractional and notional trading explains all the perks of our OMS.
- Risk management tools
Risk management tools are essential for monitoring and mitigating the financial risks associated with market-making activities. They should feature pre-trade risk checks to ensure that trades comply with established risk parameters before execution, as well as real-time risk monitoring to track positions, margin requirements, and real-time exposure. Additionally, scenario analysis should be implemented to simulate different market conditions and assess potential risks.
These features are all available through the DXtrade risk management package, which can also be tested via its full-fledged trading simulation environment.
- Charting and analytics software
Advanced charting tools help market makers analyze trends, identify patterns, and make informed trading decisions. Our financial charting library, DXcharts, excels in this area, offering indicators and tools for in-depth technical analysis of price movements, custom charts tailored to specific trading strategies, and data visualization for the graphical representation of market data, which is essential for informed decision-making.
Key features to look for in software for market making
So, what makes market-making software stand out? Here’s a quick rundown:
Speed
In trading, milliseconds matter. Good market-making software operates at lightning speed, executing trades faster than you can say “buy low, sell high.”
Customizability
Not all market makers are the same. Some focus on stocks, others on forex, and some on the crypto game. The best software enables customization to suit various strategies and asset classes.
Risk management
Markets can be unpredictable—remember what it looks like when crypto takes a nosedive? The right software has built-in risk management tools to minimize losses during turbulent times.
Data analytics
Market-making isn’t just about making trades; it’s about making smart trades. Advanced software provides data analytics and insights to help traders understand market trends and refine their strategies.
The bottom line
Without market makers, financial markets would be much less efficient. Prices would be more volatile, making it harder for investors to buy and sell assets at fair prices. In short, market makers are the oil that keeps the engine running smoothly. The software they use is the high-octane fuel that powers the whole operation.