Market Maker or Market Taker?

Have you ever seriously considered how you enter a trade? Do you enter the market as a market taker or a market maker? When I say market maker, you might picture a guy on the offer at $550.25 on ARCA for 50k shares of APPL to provide liquidity because it’s his job. Obviously most of us don’t carry the responsibility to trade that way or have access to that kind of capital. But there are lessons we can learn from market makers that will immediately improve your entry prices, and thus your performance will improve.

Most of us trade when our systems or methodologies tell us to go into the market, but what I’m concerned about is how you actually select your entry price. I’ve seen many moving average and indicator-based systems fire a signal, but only after price has moved a decent ways. By entering the market after price has moved you are effectively “paying up” to get into a trade, which makes you a market taker. In other words, you are letting the market dictate to you the price at which you enter trade. Those who trade as market takers generally trade with market orders and settle for whatever the prevailing price is. In today’s volatile yet choppy markets, it can be deadly to give up that kind of advantage. As independent traders, we have the ability to trade as market makers by dictating our price to the market, yet I’m not sure many of you take advantage of that luxury. Instead, I encourage you to force the market to give you the price you choose. Instead of trading at the market, trade away from the market on limit orders. That’s trading as a market maker.

To illustrate my point I will share a story with you. Before I launched my company, Aspen Trading Group, I wrote the daily technical analysis column at Forex.com and had the opportunity to trade for GAIN Capital’s (parent company of Forex.com) asset management company. I was one of six traders and we had access to a fairly sizable amount of trading capital. My track record in 2008 was solid so my boss called me in the office one day to tell me he was increasing my available position size―a promotion in a sense. It was great news and provided a confidence boost at first, but then reality set in. The larger trading size created significantly larger PnL swings, which really threw me for a loop. I began to hesitate on my trading entries and “paying up” as a market taker, which hurt my performance. The profits on winning trades were smaller than my averages, and the size of my stop losses were larger than my averages. Something was wrong.

So after a few weeks, I realized I needed to step back and reassess my approach because I was just not adjusting to the larger position size. I knew I was hesitating on my entries as a result of fear, so I must start there and address that issue. Specifically, I was hesitating by waiting for confirmation to see that my support or resistance zones held, watching the market move away from those zones confirming the trade, and then entering the market. In today’s tricky markets, waiting for that much confirmation is deadly because it gives away too much meat in the trade. In times when I was trading with confidence, I would place sell limits into resistance zones (or buy limits in support zones) identified by my methodology and received premium entries. I needed to get back to that position of strength.

So to remove the temptation of waiting for “ultimate confirmation,” I knew I had to get away from reactionary trading at the market and get back to trading with orders (sell limits, buy limits) at pre-defined prices, which is anticipating the market. At the time I was trading on the Barclays and Goldman Sachs FX platforms. So, to teach myself a lesson, I actually uninstalled the trading platforms from my trading computers and dealt only with the trading desk on a telephone! It was the 70s and 80s all over again! At the time, I was placing orders for sizes of $2M USD to $10M USD, which for the Goldman and Barclays desks was small business. But they knew my plan and they accommodated all of my phone trades. When placing an order in the FX markets with an investment bank, you need to be very clear with your entry prices, stop loss, and take profits and also give the sales trader enough time and room to work the order. You can’t call up a bank and offer EUR/USD 5 pips higher than the current market. You need to give him at least 20 pips of breathing room to enter the order with their desk.  

So, by forcing myself to deal over the phone, I was anticipating my entries and exits well before they were reached which helped me overcome the fear of trading larger size. Obviously not everyone has the ability to call the Goldman Sachs FX desk, but I encourage you to keep track of how many times you trade at the market versus limits and analyze you results. If you see more market orders than limits, you need to be cognizant of this. This kind of tactic can help when you increase position size or help to deal with a losing streak when your confidence is down. Trust your methodology and anticipate the market by trading as a market maker, not a market taker. You will see immediate improvements in your results.