It is really a complex task to differentiate Flow Trading and Market Making. Flow trading involves a lot of market making and proprietary trading whereas market making is important for the clients but is not possible all the time as it is tough to find a market participant with an opposite trade offer. A clear understanding of these two terms is important to learn the key differences.
In market making, the market maker assumes the risk by holding some number of shares to facilitate trading. Market makers compete for customer order flow by means of quotations. Once an order is received from a buyer, the market maker sells from his inventory.
Market makers are usually brokerage houses that are indulged in providing purchase and sale solutions to their clients to keep their financial markets liquid. But market makers can also be individuals.
The concept of market making is simple. Market makers purchase a security till the sellers get satisfied and in the case of investors who are interested in buying securities, market makers continue to sell the security from their inventory till the orders placed by the investors are filled.
Most of the traders are flow traders as they buy and sell financial products for the clients of their employer (basically an investment bank). Flow traders basically act as guides to the salespeople and to the clients in keeping them informed about the market’s direction. If the client agrees to buy a financial product or instrument, then flow traders make the trade according to the price agreed with the client.
Differentiating Flow Trading and Market Making
Market making and Flow trading can be differentiated by asking few simple questions like how the respective trader gets paid. If the amount paid to the trader based on the profit and loss is greater than the amount paid based on customers’ commission, it is purely a case of proprietary trading.
Many times, flow trading and market making look similar. But sometimes they are not. In the case of an over the counter or OTC product they are traded through dealer networks, a trader can act as a flow trader and also as a market maker. But in the case of a listed product, this is not the case. At that scenario, the sales trader acts solely as a market maker and the flow trader just trades the positions away.
All the way through our discussion, we can generalize on the fact that market makers aim at generating volume whereas the flow traders aim at managing risk. Learn more about Millionaire Blueprint for more information on different types of trading.