How Market Makers Help Us PREDICT Price with 81% Accuracy

Market makers are the most feared people in Forex. They're accused of punting your stops, slipping your orders and doing everything they can to make you lose. But the truth is far stranger than you could imagine. And we can exploit market makers to help us make even bigger profits for ourselves. In fact, I'm going to show you how a simple understanding of market maker tactics can accurately predict which direction price is going next with 81% accuracy. So stick with me and I will pull the curtain back on one of the most controversial topics in forum Forex. Most new traders understand the concept that when there are more buyers in the market, the price goes up, and when there are more sellers, the price goes down. It's the familiar tug of war between bulls and bears, to use that well known trading phrase. But if you've seen my previous videos, you know that most price moves in Forex have nothing to do with any buying or selling whatsoever. Instead, they're driven by mathematical formulas through triangular equilibrium. Well, here's another strange quirk of Forex. The price can move in the opposite direction to buying or selling pressure. There may be more buyers than sellers, but the price can still go down instead of up, and vice versa. There may be more sellers than buyers and the price will go up instead of them. And if that sounds absolutely crazy to you, keep watching. There are always two parties to a trade. The person who wants to buy and the person who wants to sell to them. In other words, if you wanted to buy $5 million, someone else would have be willing to sell $5 million to you. If you think about what that means, it soon becomes obvious that it doesn't make any sense and isn't true. If it was for a buyer to be able to buy, there has to be a seller willing to sell the same amount. It doesn't matter if their buy order is for 5 million or for 500 million. In that case, the buyers and sellers have to be equally balanced. We don't have more on one side than the other and therefore the price won't move. The buyers and sellers have canceled each other out. Alternatively, if there were more buyers than sellers, the extra buyers can't actually buy because there aren't enough people to take the other side of their trades. And therefore again, the price won't move because the extra buyers are just sat around waiting, not transacting. So this popular model of buyer and seller interaction is clearly inaccurate. Instead of thinking in naive terms of buyers and sellers, the real structure consists of customers and market makers. Customers are buyers and sellers. They can Be hedge funds, retail traders, insurance firms, mutual funds, pension funds, commercial businesses, or even tourists going on vacation. Anyone who wants to exchange any currency. Market makers are the service provider who make foreign exchange possible. They will sell to any customer who wants to buy and buy from any customer who wants to sell. Obviously then there is an interaction between buyers and sellers. But understanding the complexity and the dynamics of how market makers operate is vital to be able to predict future price movement. A market maker, as the name suggests, make a market. They are essentially a middleman. And I'll use the analogy of a fish market to explain this. When a trawler comes into harbor, they don't want to have to travel around the country looking for fishmongers who might want to buy their catch. And similarly, the fishmongers don't want to have to travel to various ports looking for boats that may or may not have the fish that they want. So a resourceful entrepreneur makes a market to offer convenience for all parties. The fishermen know that they can always sell their entire catch to the market. And the shops know they can always find whatever they want all in one location. The fishermen and the shops all become customers of the person who made the market. And if you want to buy or sell fish, you go to the market, know when they will either take what you've got or they will supply you with what you need. The market maker obviously doesn't provide this service of convenience for free, veering business for profit. So they buy from the sellers at one price and they sell to the buyers at a slightly higher price. In bricks and mortar business, this is called the markup. In forex, we call it the spread. Now in that example, the product is fish and it's paid for with the domestic currency of that country. In forex, the product is a currency and it's paid for with a different currency. And the basic market maker business model is this. They buy 1 million euros from one customer at the big price, which cost them $1 million. That's then they sell 1 million euros to a different customer at the offer price, and that customer pays them 1 million and $1,000 for it. The market maker has just made $1,000 profit. Ideally, the market maker hopes the price never moves so that they can repeat these transactions over and over again as many times as they possibly can. So at first glance, it appears to be a risk free way of making money. But they are risks involved. Forex is the biggest market in the world with more customers than anywhere else. And it's decentralized. Unlike stocks, which are Managed in one place by one exchange. Forex has hundreds of exchanges and anyone can be a market maker. So there is a lot of competition. If one market maker quotes these prices, another could undercut them. If you're a customer wanting to sell, you are going to sell to whoever is willing to pay the highest price. And likewise, if you are a customer looking to buy you, you want to pay the lowest price. So it makes sense that market makers are going to try and be the most competitive to attract the most customers. And they are around 50 major market makers who dominate the majority of Forex trading. So there's no guarantee that one who buys at the bid is going to be able to immediately sell for profit at the offer. A different market maker may undercut them and take that customer, which means the first market maker is effectively left with an open position. And anytime this happens, it's called an inventory imbalance. And remember from my previous videos that prices can move due to triangular equilibrium. If the market maker buys 1 million euros at the bid and the price, for whatever reason, falls quickly, they are now in a position where they would have to sell for a loss. So market making in Forex is not risk free. So to protect themselves against those risks, market makers trade small and they don't use leverage. Bear in mind that the Forex market has a daily turnover of over $7.5 trillion. An order of $1 million is tiny. And if market makers are doing tens of thousands of these transactions every day, losing occasionally is not that big of a deal. It's a low risk, high reward business. By trading in such tiny amounts, they never expose themselves to excessive risks. And this is the crucial point that explains how prices really move. Typically, a market maker will only quote 1 million units at each level, and very often it's even less than that, depending on the pair. But of course, there are lots of market makers. So market maker A may quote these prices. And remember I said that market makers sometimes have an inventory imbalance. So just like customers, each market maker will have a slightly different objective. Some will be more eager to buy and others will be more eager to sell. So market maker B quotes a more competitive bid in an attempt to buy from the next customer customer, but a worse offer. And every other market maker does something slightly different. All you see on your charts are the very best quotes that we call at the market. But behind that are the other bids in offers. And this is what creates what is known as the depth of market and liquidity. Highly liquid markets are those that have large order sizes, crammed closely together, often with multiple market makers overlapping each other. An illiquid or a thin market is one that has small orders or widely spaced apart. Liquid markets are safer and easier to trade, whereas illiquid markets are more volatile, riskier and harder to trade. Forex is the most liquid market in the world, and due to the nature of the way the many market makers compete with each other, the depth of market usually looks something like this. With most liquidity close to the market where the most competition is, and gradually thin and out the further away you get. What should now be obvious to you is the liquidity provided by market makers is considerably less than the size of the orders that you hear about in Forex. And this is precisely why prices move. If a customer placed an order to buy 50 million euros, there isn't someone on the other side ready to sell that amount to them. We already know that if that was the case, the buy and sell would cancel each other out and the price wouldn't move. What actually happens is the order for 50 million is submitted and it's filled by multiple different market makers at different levels. In small chunks, an order of that size would probably consume the liquidity out to 30 to 50 levels, which is only 3 to 5 pips. An order of 500 million would move the price much further. This is why price does move and why bigger orders move the price further. And this is also the reason why understanding market makers and liquidity is so important for understanding and predicting trends. Because of the way market makers profit from the spread, they tend to quote equal amounts at the bid and the offer. That's how they balance their inventory. And even though each market maker may quote different amounts from one another, when totaled up, liquidity is usually evenly balanced on both sides of the market. And when it is balanced, the price will move according to the imbalance between the customers in each direction. If the liquidity was 50 million on both sides and customers wanted to sell 30 million but buy 100 million, the price is going to go up, not down. That's more like the classic situation that people think about when talking about buyers and sellers ain't numbering each other. But sometimes liquidity isn't evenly balanced. There may be 80 million on one side and 10 million on the other. If customers wanted to buy 40 million and sell 30 million, clearly the buyers outweigh the sellers, but the price is going to go down, not up. The offer side liquidity is more than double the amount that customers need, and therefore it simply absorbs those orders. Whereas on the bid side the customers are selling three times as much as the liquidity is providing. And so the customer orders are going to eat straight through that and push the price lower. Technically, the buyers outweigh the sellers in the way amateurs think about it, that the price goes down, not up. That's because the price is more likely to travel in the direction of least liquidity. Liquidity effectively acts like resistance to absorb customer orders. The more liquidity, the harder it is for customers to move the price. The less liquidity, the easier it is for customers to move the price. Stanford universally researched this in a comprehensive study and they discovered that when an imbalance of 10 million or more existed in liquidity either side of the market, the next price move would go in the direction of least liquidity. And that prediction was accurate 81% of the time. Remember that point price is more likely to move in the direction of least liquidity. And it's important to understand that market makers respond to customer demand. If there are no customers, market makers won't aggressively be competing with each other. One or two will still put quotes out there, but most are doing nothing, or at least they're not being competitive. There's no point they there are no customers to compete for. Whereas if there's a flood of customers, market makers will quickly begin to compete to have the best price and attract those customers. The more aggressively they compete, the more liquidity there is and the narrower the spreads get. And that is good for us. Taking advantage of liquidity imbalance is highly profitable. Traders who exploit this make the most money. But that's for a different, more in depth video later. What I wanted to show you in this video was how market makers operate, who they really are and dispel some of the negative myths that taunt amateur traders. Market makers are service providers. They offer convenience and we couldn't trade without them. They are not the enemy, they're not brokers and they do not match buyers with sellers. They deal separately with sellers and separately with buyers and their main goal is to profit from the spread. They do not move the market and they do not care about you or your stop loss. They're not out to get you. There is no conspiracy, but if you understand how they work, you can use that knowledge to make yourself very rich. So don't miss my next video where I'll explain how the big banks do move the market. So if you found this interesting and helpful, please like the video, leave a comment and subscribe. It will really help the channel and I can keep making content like this to help you. These are just basic introductions to some of the topics I will create more detailed videos about, including a full series of training or for free that you can use to turn yourself into a successful and profitable trader. So remember to subscribe and I will see you next time.