Market Maker Brokers: Is It Bad or Illegal to Be a Market Maker?
One of the LuckScout followers, Singh, asked me a question that made me write this post. As we always talk against market maker brokers, most traders think it is too bad to be a market maker and it can be even illegal. They wonder if market maker brokers are really bad why there are still too many of them and why it is not illegal to be a market maker.
Before I tell you whether it is bad to be a market maker or not, first I have to explain what a market maker is.
What Is a Market Maker?
There are some complicated definitions over the Internet for this. But I am going to make it as simple as possible.
I am a market maker if you buy and sell currencies with me. To do that you have to contact me and ask for the prices and fees. For example you want to pay Swiss Franc and buy $1000 USD. I tell you that I charge you 900 CHF to give you $1000 USD. You agree and pay me 900 CHF and get your $1000 USD. I hold your 900 CHF until someone else comes and pays another currency to buy CHF from me.
Who is the market here?
I am the market, because you deal with me, not anybody else. So I am the market maker here, because the market is me. I give you the price, I buy from you or sell to you.
Why am I doing this?
I do it for profit. First of all, I charge you a service fee or commission whenever you buy or sell. Second, I make profit from the difference of the bid and ask price (buy and sell prices) which is the spread. Above all, the price I offer you is determined by me. Although it can be too close to the real market price, but it is different because I am free to offer you my own price. Just refer to few different banks in your city and ask for the USD price. Although their prices are so close to each other, but they are different and are not the same. Also the spread they charge you is different.
If the value of the currencies that I hold goes up, I will make a lot of profit, and visa versa. Therefore, I like the value of the currencies that I receive from you to go up, and the value of the currencies that I sell to you to go down. If the opposite happens, I lose money. In the above example, I took 900 CHF from you and gave you $1000 USD. If you come back the next day to give me your $1000 USD and receive your 900 CHF back while the values are changed and $1000 USD costs 800 CHF, then 100 CHF will be my profit because if you give me your $1000 USD I will give you 800 CHF only.
So getting different currencies from people and holding them can be profitable or risky for me.
Is it bad to be a market maker?
Absolutely not. I am offering a service that you need. We are both benefited from this service. I make profit and you get the currency you want. Also if you think the prices I offer or the fees I charge are not fair enough, you can refer to another market maker or dealer. It is your own choice. However, as I have too many competitors, I have to offer competitive prices and fees to attract more customers.
This is exactly what market maker brokers do, with this difference that they offer their service online and you can deal with them through a software which is called trading platform.
It is not bad by itself to be a market maker. It is a service that people need. However, when a market maker tries to cheat its clients to make more profit or prevent them from making profit, it becomes a bad market maker. Sometimes they do this only because they want to make more money (greed). Sometimes they do it because they are afraid of losing money (fear).
Online market maker brokers can deal with thousands of traders through the Internet. As over 95% of the traders lose on their own, market maker brokers make profit automatically without having to cheat their clients. However, sometimes they get greedy and make some tricks that cause their clients to lose faster and easier (e.g. stop loss hunting). Sometimes some other clients make a reasonable amount of profit which is the broker’s loss, so that brokers have to cheat the other clients to become able to pay for the profit the other clients have made.
These actions make the clients unhappy.
Online market maker brokers cheat because they don’t know how to manage and balance between the clients losses and gains. They only make money through the clients losses and this makes them vulnerable to possible big losses when the other clients make profit.
Strong liquidity providers are also market maker, but they don’t cheat their clients. The reason is that liquidity providing is not the only source of income they have. They make money through too many other services they offer. They also participate in too many different investments. The money that floods in their company through liquidity providing for retail Forex traders will not be just hold by them. They use it to offer the other services to the other clients like loans and mortgages, or participating in different investment opportunities. So they make money with the traders money. Therefore, they don’t care even if some traders make profit, because they have already used the money to make profit through the other ways. And of course they also make money when the other traders lose money.
This is how a strong liquidity provider can manage and balance between the losses and gains and remains profitable almost all the time and keep on offering its service. This is what market maker brokers don’t do, don’t know how to do, or are not big enough to do. That is why they have to balance through cheating the clients.
If you make money while trading with a strong liquidity provider, they not only don’t cheat you to make that you lose, but also they appreciate your business because when you take a position, your money will be added to their treasury, and so they can use it instantly to offer the other services or invest with the other companies. They have too many specialists who manage these affairs for them. But most retail market maker brokers cannot afford to do that.
So, it is neither bad nor illegal to be a market maker. It is bad and illegal when a market maker cheats its clients.
Learn more about market maker and ECN/STP brokers:
- Market Maker Brokers Hate Me
- How Do the Liquidity Providers Make Money and Are They Market Maker?
- The Difference of True and False ECN/STP Brokers
- Electronic Communication Network Or ECN Brokers