The trading world is full of difficult dynamics that make it one of the most competitive activities on Earth.
This is one of the environments where human beings need to compete at the highest levels and commit to their maximum capacity to be successful.
The winners can be called so because of their immense knowledge of the markets and the unique efficiency of their ideas.
This is the case of the market maker — his edge is a very profitable source, the fruit of clever business management.
Market makers and retail traders represent two opposites, yet one can’t exist without the other.
In this article, we will examine the edge of the market maker over retail, and how to compete as a successful individual trader.
The base reasoning
Firstly, it is needed to specify that not all the market makers work in the same way and with the same intentions. We will concentrate on the market makers that compete with the mass of retail traders.
If you want to deepen into the figure of the market makers and who they practically represent, read this article before continuing.
The great Mark Douglas, in his “Trading In The Zone” workshop, cites:
“The underlying philosophy that we operated from was — all traders are terminal and it is our job as a broker to make them as comfortable as possible until they expire”.
What he was trying to say was that brokers and market makers know their job.
They know that the only thing between them and traders’ money is time. After all, they are financially very wise and have the patience to let time do its work. These figures already did their job before you even start the account, by building up their edge.
Generally, the broker has the goal to keep you in the market because his profits come from the commissions. The market maker broker/exchange has the same goal, plus he competes with you because he is the one that occupies the other side of the trade.
The broker or the exchange that can be classified as “market maker” will likely have its profits in the liquidation of the trader’s account.
You have two choices: being on the other side of their trades or being on the same side of the table.
Understanding their edge
To understand where their most powerful weapons come from, it is necessary to identify the most prominent weaknesses of their opponents, i.e. retails.
About this, the market maker’s edge is based on a very simple concept that the average retail unconsciously bypasses.
He knows the weaknesses of his opponents and how to exploit them to win the game.
After all, how do you win a game if you do not apply what you know about your opponent? Being a winner is not just becoming stronger, it’s also having control and sight over the environment.
The weaknesses of the retail traders
Generally speaking, the main retail weaknesses that the market maker uses to develop his edge are three:
• Retails can be influenced
• Retails are uneducated
• Retails are impatient
Retail’s vulnerability to influence
It is widely known that the market makers have the power to influence the mass by creating information or events and generating bias.
This is possible only because the retail lives in a highly conditioned state of mind — his mind depends on external impulses and influences to obtain a view and a personal conviction over the environment.
In simple words, he is shaped by external conditions. We can say that the retail trader is reactive.
Verily, it is much difficult to realize how one can be free from the influence of external conditions: no one will ever say that their conclusions are influenced by the outer world. And yet, this is exactly what happens.
The road to integrity and proactivity is long and tortuous — it is needed strong will and control to switch the wires.
Be aware that this dynamic is not the fault of the market maker. The responsibility is solely upon the retail and of his steady unwillingness.
The retail trader that wants to be free from this vulnerability, has to be steady in his WILL of being proactive.
Retail’s illiteracy
This weakness speaks for itself. Being uneducated is a very powerful and effective way to lose everything against those who instead are very well prepared in their activity.
Most retails join the game just for their greed. When their desire is weaker than their greed, they don’t bother to be literate on what they’re doing.
This eventually causes the average retail to be vulnerable to those dynamics that, before being able to engage with them, require a solid knowledge of the trading concept and of capitalism itself.
The market maker is a master of his profession and ignorant opponents are very easy targets.
To escape illiteracy, there’s only one thing to do — study and experience.
It’s also very necessary to say that the retail has to be capable of finding the right source of knowledge, and must avoid wasting time on fake and unuseful information.
Generally, the most righteous source is the market itself. It is the greatest teacher of them all.
Retail’s impatience
Impatience becomes dangerous when backed by greed.
There’s a very big misunderstanding in the common bias — that the market makers are the greedy ones. Remember that greed is a weakness, and no weakness is going to be a source of positive growth.
When the retail gets impatient because of his greed, he overloads his boat with plenty of risk and he ends up sinking.
Impatience is also what causes the retail to FOMO. It makes him forget that the market will ALWAYS offer opportunities to those who deserve them.
All these dynamics are clear in the sight of the market maker. He is very patient about his profits and develops his edge around those who are not.
The retail that wants to escape from this, needs to transform this weakness into a strength, by changing the source of his impatience.
The average retail is impatient with his desire and patient with becoming worthy of his desire.
The successful trader is patient with his desire and impatient to become worthy of his desire.
Techniques of the market makers
The market maker eventually blends all the knowledge acquired by analyzing the retail behavior into two main effective techniques — Reverse Psychology & Risk Incentive.
Reverse psychology
The reverse psychology used in the markets is the ultimate proof that trading is all about mind and self-mastering.
One of the most powerful weapons of the market makers, having vast freedom in terms of capital, is to induce a bias in the environment.
The market maker can create an event, a narrative, a movement in the market, an influent character, news, and other stimuli to direct the majority of people towards a pre-determined direction.
Being most human minds influenceable and manageable by external agents, this process is particularly effective.
But why do they need to induce herd psychology?
Having a large amount of capital, they need to find a matching size to complete their transactions.
By directing the mass of little capital towards the other side of the trade, they have enough liquidity to realize the trade.
The Von Restorff effect
Reverse psychology is also important in the identification of those levels where most retail traders are going to put their stop orders.
This branch of the technique is developed around the Von Restorff effect. This particular behavior of the human mind induces itself to concentrate on the stimuli that differ from the others in a given environment.
When the retail sees something in the charts that inspires him to set his stop orders, there’s a probability that he is a victim of the Von Restorff effect.
The market makers often create certain structures in the market that are supposed to point out specific levels. These levels are eventually targeted by retails for their stop orders.
The market maker will take advantage of those levels to get the necessary liquidity for their trades.
Risk Incentive
Market makers are very literate about risk. Their business has very little risk compared to their edge. They know that risk is the component that dismantles the edge.
The risk can be considered as the quantity of edge that is being sacrificed. It can represent the “sacrificed chunk” of the edge.
When the risk is discreet, it removes just a little chunk from the efficacy of the edge. But when the risk is unsustainable, it eats away too much of a chunk and the edge is dismantled.
The market maker is perfectly aware of this and he incentivizes the retail to increase his risk — in this way he neutralizes the retail’s edge and wins easily over time.
In the case of market maker brokers/exchanges, what seems to be larger freedom and a bigger choice of financial instruments, often is just a way to increase the risk of the retail trader.
The case of leverage
Certainly, nobody gives free money to anyone.
When you have free money available, as in the case of leveraging, there will be important outcomes that can turn against you if you’re not acknowledgeable enough.
Before giving the possibility to make huge gains, leverage has the role to increase the risk. Market makers are going to give you all the leverage you want. However, that means increasing your risk.
A huge amount of leverage equals a huge amount of risk — that is the dynamic that annihilates your edge.
Leverage helps the market maker’s edge to win over yours. The more leverage you want to use, the more astounding your edge needs to be.
How to compete against the market makers as a retail
If you want to profit against market makers, you need to know the game well and be very good at it.
Specifically, you need to decrease or annihilate the impact of the market maker’s edge over your edge.
Remember that your profit derives from that percentage of risk that the market maker has calculated for its business — that risk represents the ones who know their craft. You may want to be part of that group of traders.
Being a successful trader firstly means dissociating from all the weaknesses that make an average retail trader. This decreases a lot the impact of the market maker’s edge.
Moreover, the retail trader can recur to three powerful advantages:
1. Trading long term
2. Trading emotionless
3. Thinking like a market maker
Trading long term
By developing your trading process throughout longer timeframes you are less susceptible to reverse psychology techniques and emotional impulses.
A wider perception of time helps the trader in bypassing all the short-term events and influences that otherwise would appear a question of life and death.
Market makers have a very wide sight and can see long term. In addition to that, they are also responsible for the majority of short-term events that incur into the market.
This means that they eventually know what the short-term outcome will look like. Would you compete with someone that has a lot of control in that game?
Be aware then, that you must have something very effective, something that permits you to escape that control.
Moreover, traders that focus on the long term can avoid being stopped out, because they usually use wider stops, as opposed to short-term traders.
Trading emotionless
Being emotionless in the markets means being unconditioned.
A trader that is not vulnerable to the conditions is not influenced by any biases and can see things from a clearer perspective.
This represents the strongest armor against psychological manipulation because you are now the manager of your psyche.
The market maker’s edge can also include inducing emotional impulses through the market conditions he creates.
When the trader does not respond to those impulses, he neutralizes the psychological effect of the events.
Moreover, emotions will not interfere with the proven strategy, and the trader can execute his plan without impediments.
Thinking like a market maker
This is a game-changer. When you start to think like a market maker, your paradigm switches along with your trading.
If you had all that capital in your hands, you would need a lot of liquidity. Where do you take it?
It’s simple. You take it in the moments when the majority of retails do the same thing. For such times to exist, conditions need to be created, so that people will react in the same way.
If you need to make a large buy, you take advantage of the events that lead people to sell all together.
You have now completed your large buy. But at some point, you need to sell too.
Just repeat the process: create a narrative, spread news, try to convince the herd to reunite their capital into a big overall buy, then sell your assets through that liquidity.
In conclusion
The market is a stupendous environment and it involves almost all of the characteristics that make a human being.
Those who can manage their advantages and weaknesses to build an effective edge are the ones that can truly profit from it.
The market makers are surely among those who are provided with the best edges.
Besides enhancing their strengths, they study the weaknesses of those who take the other side of the trade and build their edge around them.
They often trade with retail traders — this is why most retails lose money.
To compete with market makers, it is needed to match or exceed their level in order to neutralize their edge.
Firstly, this implies getting rid of those retail weaknesses, then it requires the trader to develop a strong mindset and a truly valuable edge.
By committing to the same degree as market makers commit to reaching their goals, the retail trader can deservedly become a successful trader.
Everything described in this article has the sole purpose of being informative and providing general information. The author has no intention of providing any financial advice, legal advice, or tax advice. Do not rely on this article to make investment decisions. Seek professional help before making any such decision. The author does not take any responsibility for loss or damage of any nature. The use you make of the information contained in this article is your sole responsibility.