An electronic market maker is a company that offers pricing on electronic trading platforms and consistently places limit orders to buy or sell. It supplies liquidity to traders who need immediate execution through marketable orders. Some electronic market makers also provide continuous price streams either directly or through electronic platforms.

If you are not familiar with how an electronic market maker processes a trade, here’s a simplified workflow:

• Current market rates are gathered.
• Risk algorithms are utilized.
• The bank sends out two-way quotes to clients via their platform or API.
• Clients execute a trade.
• The bank’s desk takes the opposite side of the risk and confirms the trade.
• Risk is managed internally, either from another client or through hedging.
• The process repeats.

This overview provides a basic understanding of a bank’s electronic FX (eFX) desk. This process operates on a millisecond scale, continuously updating rates, adjusting spreads to align with market conditions, and maintaining an appropriate level of risk. All of this occurs simultaneously for hundreds of clients across over 50 currency pairs and 550 cross-currency pairs.

For the most part, operations on an eFX desk are automated. While the quotes issued can be manually adjusted to better reflect the market when the model fails to accurately determine rates, the hundreds of thousands of quotes sent out daily are typically dictated by the bank’s risk algorithms established by the quantitative division.

As a market maker, you have no control over the risk that enters your book after you provide quotes to clients. In the case of eFX, when quotes are automated, there is even less control over when your risk fluctuates. The primary responsibility of an eFX trader is to manage currency risk.

Although predicting future risk in your book is impossible, being an eFX market maker offers the advantage of having a significant amount of offsetting risk entering your book as well. Consider two client trades that come in 200 milliseconds apart: one is to buy 1,000,000 EUR/USD, and the other is to sell 500,000 EUR/USD. As the market maker, you take the opposite side of the trade, resulting in a short position of 1,000,000 EUR/USD and a long position of 500,000 EUR/USD. This leaves you net short 500,000 EUR/USD.

Most likely, the market hasn’t moved beyond the spread during those 200 milliseconds, allowing your book to earn the spread on 500k EUR/USD, while you now need to manage the risk of your 500k EUR/USD short position.

When you apply this scenario thousands of times a day across trades ranging from 1M units to 100M units across more than 50 currency pairs, it becomes clear that being an eFX market maker is more about managing holistic portfolio risk and macro trends than focusing on the risk from any single trade.