What You Did Not Know About Market Maker Traps
What is the market maker:
In forex trading, market makers function as intermediaries in sales and purchases between two parties and two currencies. For example a bank will function as a market maker when it collects sellers of the US Dollar to then sell to investors who have Euros in exchange. The value of each currency is based on the current market value.
To beat the MM you need to understand the basic objectives of their activity. Overall, the MM’s are traders and their objective is to make money. This includes strategies to trade against retails traders. The major difference between them and other traders is that they have the ability, through access
to massive volumes, to move price at their will. So to make money, they aim to buy at a lower price and then sell at a higher price. They achieve this by:
- Inducing traders to take positions
This is achieved by using a range of price movements to ‘trick’ traders into taking a position in a given direction but then reversing it again. This means that the MM can sell a specific currency at a
certain price and then buy it back at a lower price when the retail trader feels too much pain from the currency value moving backward and wanting to sell it back again (e.g. via the stop loss).
2. Create panic and fear to induce traders to become emotional and think irrationally. This often involves:
- quick moves
- spike candles
- news releases
- ‘inexplicable’ price behavior.
2. Hit the Stops and Clear the Board
This forces traders into ‘margin trouble’ and ultimately out of the game.
What tools does the market maker have?
Even though they have a number of tools at their disposal, they do have some restrictions imposed on them from outside authorities. These include:
- The IMF restricts their ability to move price to a general range so as
to avoid a collapse of the market.
- This is generally limited to the ADR and will involve moves of as
much as 200 pips per day in most pairs.
- They do not have unlimited equity so it is necessary for the market makers to close positions and regain balance periodically.
The only tools they have are to be able to buy or sell currency in different volumes at different prices. By doing this strategically, they can:
- Entice traders to take positions by providing evidence that price is or
is going to move in a certain direction.
- Appeal to the emotional side of traders by changing the character
and speed of price changes.
- Once the trap has been set, and the bait taken, cause the price to
move in such a way as to cause price to move against the traders,
allowing the banks to buy currency back from or sell currency back
to the traders so that they are square again.
- This means that the trader has entered the market by buying
currency from the bank at a given price and exited the market by
selling back to the bank at a lower price. Conversely, the bank has
sold to the trader at the higher given price and bought back from
the trader at the lower price.
What tools do the dealers and the brokers have?
Brokers and dealers have mechanisms available to them for manipulating price to enable the process of taking money from traders, who are also their clients!
Usually, trader’s transactions are dealt with ‘in house’ and never make it to the interbank market so it is very easy for them to manipulate price to their own advantage. They have a number of additional tools at their disposal and include:
- Trigger all stops in a given price range (which is part of the dealers functions in the MT4 platform)
- Vary the spread (which is why scalping methods often fail) at times when it is an advantage to them to do so.
- Throw a price spike to take stops out, bear in mind that they know where the stops are.
- Target traders who are in margin trouble and move price against their positions to “finish them off”. Again bear in mind that they know who is in trouble because it is part of their backend platform.