Ask a Market Maker Q&A on Currency trading… 6/27/15

An interview with Elliot Mayerhoff Market Maker and Mark Coe

A Risk disclaimer for currency trading with leverage:  Consider the risks associated with increasing your leverage. A relatively small market movement will have a proportionately larger impact on the funds you have deposited or will have to deposit; this may work against you as well as for you. You may sustain a total loss of initial margin and you may be required to deposit additional funds to cover a short margin position.

Do Market Makers gun for stops?
Buy or sell orders with stops go into effect after the stop level price is crossed. This is how stops are used – Market Makers (MMs) are able to see these stops and also have a good idea where traders place stops. The concept in the retail trader’s world is that Market Makers (MMs) gun for stops. This is particularly prevalent in the Forex currency trading world. There is a bid and an offer. Professionals and larger buyers will say to buy it at bid or do the best you can. MMs in the big banks are not too concerned about going after the retail traders specific stops. That does not mean the MM will not go after certain specific levels. Euro has a very good liquidity and it is traded very tight. 1-2 ticks. 150 (million) euros would normally not move the market; but who has that order may be of interest. Banks and traders want to know whether that is a Fibonacci level. The bank trader wonders - Is there a cluster of stops at that level? The more stops at a level and he may want to buy ahead of those levels and formations. Who is giving me this order? Most traders are paranoid. If it is from a large bank he may be wondering – does the person placing his stops know something I don’t? Maybe he will start running the stop. There are a lot of variables. Who is leading the order?  Is it smart money? The bottom line is MMs are not going after any one stop.

Do bank traders use fibonacci levels?
Definitely. You want to combine different time levels and see where the fib levels fall. For example using daily, weekly, hourly and if you have a fib level around the same area, then that is stronger.

Is the MM controlling the market? The answer is yes; unconditionally, yes. But there is competition out there. He is not able to get around to do something unscrupulously to profit. Right now MM is the house. If I call up a bank and the MM and tell him “I want 1.1377-79 as a buying price range… he tells you 1.1387-89… I say “I think you meant 1.1377-79…” No… the MM/bank is saying “I am a buyer. Why shouldn’t I have the right to make the market”? If you wanted to sell at 1.1387-89, you can. MM can show him any market he wants. MMs do not have days to set things up however…  MMs no longer have deep pockets. To a certain extent the MMs do control the markets.

Liquidity in the FX markets - Is FX really the most liquid markets? What happens during announcements? Non-farm payroll … 8:30 am EST they stop quoting. Only desk levels are open. Whoever leaves a stop, they would call and check if you want a stop… it could go 50 points through your market stop.

If you sell or buy outside of the US there is going to be the need for a hedge.  MM has to hedge out options. MMs just want to play volatility and not direction of the market. Before you had the FIX at 11:00 am EST.  Bigger banks would get in a chat room. It is small world with MMs. MMs and Traders could sell using a chat room and reach a deals with a buy and sell privately for large quantities. If they all have a lot to buy, then they would discuss how they will collude. They arrange amongst themselves and the customer gets s*&%#%d. They drive the price up higher but have been buying it earlier… This is the 11 O’Clock fix. How do you buy 5 Billion dollars in 1 sec? That is a lot of money at any time. This is however no longer the case as banks are looking at chat rooms.

Do the big, smart people get it wrong sometime?
You only hear about the success. No one talks about all the failures in professional sports, just the successful ones. There are many hedge funds going out of business. John Paulsen made a lot of money in the sub-prime, getting it right … $1 Billion… but many of his customers lost a lot of money after that. You don’t hear about that. The percentages are much worse than 30% winners. You only hear about the winners. Not the losers. Many hedge funds went out of business.

MM got to see both sides of the deal. What did the successful ones do? 

Traders all have their own style. Everyone has to understand their own style. MM would say that the guys who were more successful were the ones that were looking for a longer point of view. People that understood risk management and riding the trend did better. People who had more staying power did better. They rode a trend that was playing out in the market and those were the ones who were most successful.
There were a lot of successful people. There was one who traded every day in the morning. He traded the USD/Yen. He always came out every day on the right side by trading 3-4 hours in the morning. A trend following trader will do well when it is trend trading. He will get killed when it is going sideways. But the better trader are the ones who have good money management. High frequency traders are short term traders and they have kept volatility down… They are the algorithmic traders. There are more algorithmic traders who are trading on a very short term. Many are successful.