A Market Maker is the counterparty to the client. The Market Maker does not operate as an intermediate or trustee.
A Market Maker performs the hedging of its clients' positions according to its policy, which includes offsetting various clients' positions, hedging via liquidity providers (banks) and its equity capital, at its discretion.
Who are the Market Makers in the Forex industry?
Banks, for example, or trading platforms who buy and sell financial instruments at the market. That is contrary to intermediates, which represent clients, basing their income on commission.
In recent times there has been a big boom of online Forex brokers, there are no longer just one or two dominant market makers. Even more recently trading platforms have begun to reduce their minimum deposit levels bringing in accounts known as Mini-Forex accounts. These accounts often have minimum deposit levels of less than $100 making Forex a far more attractive market for the public than ever before.
Do Market Makers go against a client's position?
By definition, a Market Maker is the counter party to all its clients' positions, and he always offers a two-sided quote (two rates: BUY and SELL). Therefore, there is nothing personal with the trading conduct between the Market Maker and the customer.
Market Makers regard the total positions of their clients as a whole, same goes for banks and other market makers in the Forex market. They offset between clients' opposite positions, and hedge their net exposure according to authorities' guidelines and their risk management policies.
Certain market makers such as trading platforms will offer a managed Forex account, this means that they will work with you to help ensure you are always trading effectively. Because of the genetic make-up of the Forex industry a managed account can be very beneficial to both the trader and the platform.
Do market makers and clients have a conflict of interest?
Market makers are not intermediates, neither portfolio managers, nor advisors who represent customers (while earning commission), but rather they buy and sell goods to the customer. By definition, the Market Maker always provides a two-sided quote (the sell and the buy price), hence maintains neutrality as for the client.
Banks do that, same with merchants in the markets, who buy goods and sell it to customers. The relationship between the trader (the customer) and the Market Maker (the bank; the trading platform; etc.) is simply based on fundamental market forces: supply and demand.
Think of a market maker as a shop, they buy in certain currencies and then sell the currencies on based on demand. Of course they may sell some currencies for more than they bought them for hence they make money. The advantage of this for the day trader is that no commissions are charged on transactions so the shine of a profitable trade cannot be taken away!
Can a Market Maker influence market prices against clients' position?
Definitely not, because the Forex market is the nearest to being a "perfect market" (as defined by economics theory).
This is the biggest market today, reaching a daily volume of 3 trillion dollars throughout the globe. That means that there is no single participant in the market, banks and governments included, who can consistently push the price in a certain direction. It is the traders and the public that determine the demand for currencies and therefore their price and any rises are falls in value.
How do Market Makers manage their exposure?
The way most Market Makers hedge their exposure is to hedge on bulk. They aggregate all clients' positions and pass some, or all, of their net risk to their liquidity providers.
Think of it this way, a large distributor buys in thousands of units of a product and then re-sells them for a higher price, the distributor does not need to sell all of its stock at full price to make a profit since it acquired the product at a cheaper than retail price in the first place. Whilst the Forex market obviously has some major differences, the principles are the same.