Effective Market Making Strategies
What is market making?
Market making is a trading method usually deployed by large firms to provide liquidity to different markets. However, we will only focus on the retail version of market making.
The concept in market making is consistently providing liquidity in the market and hoping to sell the position you have built while providing liquidity for a profit. Profit margins are usually extremely small and daily executed number of trades are extremely high.
We will continue onto this article assuming we are trading futures contracts that are settled in USDT. However, you can execute the same strategy for spot market or inverse swap contracts. While only difference being unable to short the market for spot trading.
What our advanced market maker bot in action
https://www.youtube.com/watch?v=yxsETCO_dgM&t=185s
How does a market maker make money?
There are 3 potential different ways a market maker makes money.
Fees: Depending on the exchange you are using; you might pay or receive a rebate for your trade. For example, Bitmex and ByBit pays a rebate fee of 0.025% for limit orders. While, exchanges like Binance and FTX charges 0.02% for limit orders.
If we use an order size of 0.001 BTC (minimum order size for USDT contracts) which would cost us 0.1$ in margin, we would receive 0.0023$ in rebate fee from Bitmex and ByBit. However, we would be paying 0.0019$ to Binance and FTX in order to execute the same trade. As a result, it would come to a net difference of 0.0042$
Even though, the fees look extremely small, market makers will execute around 350–700 trades per day which can add up extremely fast and increase the cost of trading. So, it is highly advised to pick your exchange right. Read our exchange guide here.
Closing Position in Profit: This is more straightforward and less dependent on the exchange of your choice. Market makers aim for small margins anywhere from 0.1% to 0.5%. They maintain a limit take profit x% above their entry level.
Funding: Funding isn’t always going to be on your side. This is the downside of trading futures market compared to trading spot market. Every 8 hours exchanges charge a funding rate to keep your position open. 90% of the time funding is positive 0.01% which means longs pay shorts 0.01% of their open position’s worth. If you are a short side market maker, you have nothing to worry about. However, if you are a long side market maker, you need to take funding as an expense into your calculations.
Effective MM Strategies
Market making is an extremely simple yet an effective strategy, which makes it hard to make adjustment that will improve the strategy. Though, we found that there are a few tweaks you can perform to make the strategy safer and more effective.
Try Trailing Take Profit: Most retail market makers use limit take profit orders to benefit from the rebate fee. While there is nothing wrong with that, they often miss bigger profits on the price actually continuing to trend right after they got out of their position. If they were using trailing take profit, they could have sold the position for an extra 0.1–0.2% profit which would outweigh the rebate fee they would have made.
Place Multiple Orders: Instead of placing one order at a set interval, place multiple orders with a set spread percentage between them at a set interval. If the price crashes quickly, you get filled at lower prices which brings your average down and results in better entry price and more filled trades. “Scam wick” is a common term in crypto where prices either crash or pump extremely quickly and retrace back to the starting point just as fast. Placing multiple orders will have you fill more orders thus, increase your profits.
Don’t Use Stop Loss: Stop loss is an amazing tool to limit your downside exposure and control risk. However, in strategies like market making or dollar cost averaging, it contradicts the whole concept. The price needs to go down so you can get filled and build a position and sell for profit later on. During highly volatile times, you might find yourself getting stopped out frequently. Instead, exercise proper position sizing and make your order size in a way that you can’t mathematically get liquidated. Therefore, you wouldn’t need a stop loss. If you are trading spot market, you don’t need to worry about this as much.
Pros and Cons of market making
Pros
· Provides daily return, for the most part
· Very high success rate
· Most of your money stays liquid and out of position
· Very low hands on trading method
· If you hedge, it is fairly safe
Cons
· It is risky if you are not hedged
· If the market trends the opposite way, you might get stuck in a position
· It doesn’t work well with stop loss, so you really have to stick to proper risk management
· Losses can wipe up most gains
Overall, market making is a widely used strategy by many successful hedge funds. Exercising proper risk management and order sizing, you can safely deploy a market making strategy even in a volatile market like cryptocurrencies.
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