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Electronic Market Maker

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An electronic market maker is a firm that provides prices on electronic trading (e-trading) venues and continuously submits limit orders to buy or sell.

It provides liquidity to those traders requiring immediacy via marketable orders. Some electronic market-makers also stream prices continuously either directly or indirectly (via electronic platforms).

If you’re unfamiliar with how an electronic market maker takes in a trade, here’s a simplified workflow:

  1. Current market rates are taken.
  2. Risk algorithms are applied.
  3. The bank streams out two-way quotes to clients over their platform or API.
  4. Clients make a trade.
  5. The bank’s desk takes the other side of the risk and confirms the trade.
  6. Risk is offset internally, from another client, or hedged.
  7. The process repeats

A lot of detail is left out above but it’s a simple overview of a bank’s eFX (electronic FX) desk.

This process is being applied on a scale of milliseconds, constantly updating rates, adjusting spreads to fit market conditions, and keeping the appropriate level of risk.

All this is being done simultaneously for hundreds of clients over 50 currency pairs and 550 cross-currency pairs. For the most part, everything on an eFX desk is automated.

While the quotes sent out can be adjusted manually to fit the market when the model doesn’t appropriately determine rates.

The hundreds of thousands of quotes sent out during the day are normally determined by the bank’s risk algorithms set up by the quant division. As a market maker, you don’t get a say in what risk comes into your book after you make your quotes to the client.

For eFX, when quotes are automated, there is even less control over when your risk changes. The role of an eFX trader is to manage currency risk first and foremost.

While knowing what risk your book might have in the future is impossible, the benefits of being an eFX market maker mean that there is a lot of offsetting risk coming into your book as well.

Take two client trades coming in 200 milliseconds apart. One is to buy 1,000,000 EUR/USD and one is to sell 500,000 EUR/USD.

You, as the market maker, take the other side of the trade so your risk is short 1,000,000 EUR/USD and long 500,000 EUR/USD. You are net short of 500,000 EUR/USD.

Most likely, the market hasn’t shifted by greater than the amount of the spread during those 200 milliseconds so your book earns the spread of 500k EUR/USD and you now have to manage the risk of your 500k EUR/USD short.

Take the above example and apply it thousands of times a day on trades ranging in size from 1M units to 100M units across 50+ currency pairs, You start to get a sense that being an eFX market maker is more about holistic portfolio risk and macro trends than the risk from any one trade.

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