How to Make 1-2% a Day through Market Making
How to Minimize Inventory Risks and Maximize Profits when Market Making.
Inventory risk is the arch-nemesis of market-making. It is because we are exposed to the risk of having our inventory being worth less whenever there’s a dip. As market makers, our ability to instantly buy and sell is due to us holding inventory of both the base and quote assets (for example, BTC/USDT). However, assuming BTC drops by 10% due to a China news flash, our BTC inventory would now be worth 10% less, thus causing us to realize a 10% loss on our base asset. (If $500, then losing 10% is $50).
My full guide delves into 6 ways that we can mitigate inventory risks. This has helped me reduce losses while market making.
In the end, I also include a secret sauce tip that has helped me consistently rank top 5 in most of the pairs I mine, all while maintaining net positive trade PnL.
I am not providing personalized investment advice, and I am not a qualified licensed investment advisor. The content is for informational purposes only, and you should not construe any such information or other material as legal, tax, investment, financial, or other advice. Seek a duly licensed professional for investment advice. Furthermore, I am in no way affiliated with Hummingbot. Thus, all I write is non-representative of Hummingbot’s view. By applying any of the information here in your trades, you agree that you are fully responsible for the results of your application.
When do Market Makers fail?
Market makers, by definition, are the risk bearers, the liquidity providers, and thus the ones to bear the brunt of losses if prices were to go in any specific direction for a prolonged period. Here are two very common situations that we face,
Market makers sell too early in any rises.
Market makers buy too early in any dips.
Selling too early scenario.
Imagine prices rising by 0.05%; naturally, your bot would automatically start hitting the sell orders, leaving you with 0 inventory when the price keeps growing. Apparently, it’s due to Elon Musk tweeting about his support for Bitcoin again, causing BTC to keep rising by 10% overnight, but you are left with 0 inventory after the initial sell your bot made. At the end of the day, you’ve made 0.1% profit through selling early, while people who HODL earned 10% without doing anything.
If only you sold at the peak, eh?
Buying too early scenario
Conversely, prices dropped by 0.05%, and naturally, your bot’s buy orders keep getting filled due to the price drop, and you start stacking up inventory. You’ve bought $500 of BTC at the “cheap” $39,000. Apparently, China announced an intention to clamp down on cryptocurrency again, and BTC dropped by 10% in 15 minutes. Your bot can’t differentiate between a steep dip vs a typical dip, all it knows is it should buy when it’s conditions are met. You bought $500 BTC that’s now only worth $450. You just made a loss of 10% in 10 minutes.
If only your bot doesn’t keep stocking up at any sign of falls.
In my guide, I talk about how to
Choose the right pairs
Identifying correlated pairs
Smart Inventory Strategies
Automated Stock Keeping Decisions
A Secret Sauce on Liquidity Mining in Hummingbot
(A Sneak Peek of Chap 2.2)
Evading the whales
Whales are the arch-nemesis of market makers. Logically then, we don’t want to market make when the whales are active.
I downloaded the past five years of hourly and daily crypto prices for BTC and ETH and tried to investigate which hours and days tend to have the most significant price changes (close - open). Knowing when price changes are statistically more significant would help us evade market making during these hours (wider spreads, or not operating).
I discovered that UTC 0000, 0800, 1200 are the times when price change happens the most. Coincidentally, these are the times when the HKSE (0000), LSE (0800), NYSE (1200) are just about to open.
Furthermore, when it comes to which day prices change the most, we discover that price changes happen most on Mondays (0 in the chart below) and Wednesdays.
Thus, it seems logical to infer that Hedge Funds are one of the most significant trading whales on crypto land. And we should take evasive market-making measures during these hours on Monday & Wednesday.
But of course, this only applies to crypto with a large market cap. Smaller Altcoins might not obey these exact hours, but there might be specific patterns you can infer from the charts as well. Go over the charts, and look for the times when there are the most significant dips and rises; try to see if it happens at the same time every time, or maybe a particular day, or a particular event. Look for a pattern.
Granted, here’s the thing. Don’t market make too much on new projects or cryptos without extensive due diligence on the project (If you’ve mined Divi, xDai, Omi, Asd, you know what I’m talking about). After all, if, in the worst-case scenario, it is a pump and dump scheme, we as market makers don’t want to be left holding a bag of worthless coin after it’s dumped. If you are still interested in taking up the challenge, maybe operate it on a small part of your portfolio instead of dropping all you have into it.
P.S: One of my Top Secret Sauce
This is it. This secret sauce is what helped me earn $1,000+ in rewards each week.
Wait - you might ask - why am I sharing this?
I am charging for my guide, so I’m incentivized by the profits.
I have other secret sauces which I’m capitalizing off. So no, this isn’t the only trick I have in my bag.
This secret sauce is not all there is. There are no free lunches. You still have to create and research your strategy to capitalize on this secret sauce. (I’m not giving you any strategies because I legally can’t, else I’m legally responsible for your PnL).
With all that said, I do credit a large part of my ~2% daily ROI on this secret sauce.
Market making is a net positive game, provided the right conditions and the right strategy. Average traders only profit when prices go up or down; we profit as long as it fluctuates around a mean. So, do your research, and be ready to fill up the bank whenever it goes according to your way. At last, here are some final tips to help you succeed.
Pick the right pair.
Pick pairs that are pump-and-dump proof, don’t be the guy who plays the ultimate victim to pump and dump schemes. Pick pairs with a high market cap, long history of stability, and where no person owns too many percentiles of the coin.
This is all market making is about. Find ways to help you predict when periods will be volatile and run from those periods.
Don’t be too greedy
Don’t try to traverse the fine line where it might be getting volatile. Remember, not losing 1% is 1% more than what the market is getting. Whenever your indicators tell you of treacherous waters ahead, it’s better just to turn it off, dump your inventory, and cut off the possibility of losses.
Don’t store too much inventory.
The only way to entirely evade inventory risk is not to own any inventory. But the only reason market making is profitable is that we act as risk-taking middlemen. So, be wise, determine the number of drawdowns (loss) in sight, ask yourself what your risk appetite is, and set your maximum inventory threshold.
As market makers, we profit through hundreds and thousands of trades a day. Fees matter. Try your best to research pairs or exchanges with lower fees. Even 0.01% makes a massive difference to your bottom line when you trade $100,000 a day.