How to Choose, Set Up, and Customize a Market-Making Bot

Desktop with laptop computer and red robot figure.

Crypto trading bots enable traders to automate the execution of trading strategies around the clock. Algorithmic trading bots that have become increasingly popular in the digital asset markets are so-called “market-making bots”.

In this guide, you will learn how to choose, set up, and customize a market making bot that will buy and sell digital currencies on your behalf in an entirely hands-off manner.

What Is Market Making?

The words profit, loss, and risk created with white dice.Market making refers to buying and selling an asset to profit from the difference between the bid and offer prices.

For example, for a stock that trades at $100 mid-price, a market maker may place a buy order at $99.90 and a sell order at $100.10 for 10,000 shares. If the market moves up and someone buys 10,000 shares at $100.10 and then, shortly after the market moves down and someone sells at $99.90, the market maker will have made a profit of $2,000 ($0.20 x 10,000). The market maker repeats this over and over in an attempt to generate a daily trading income.

In the equity markets, banks and brokerages act as market makers for the stocks that they have underwritten in the new issuance process. There is a certain degree of commitment by the broker-dealers involved in an IPO to provide liquidity for investors in the secondary market. Other market makers include hedge funds and proprietary trading houses.

In the digital asset markets, market making is primarily conducted by hedge funds, professional traders, and crypto trading bots. The latter are starting to make up an increasing number of orders on digital currency exchange order books as the use of crypto trading bots is on the rise.

Example of a Bitcoin Market Making Bot:

You could customize an algorithmic trading bot to buy and sell bitcoin (BTC) against Tether (USDT) at 0.15 percent away from mid-price with $10,000 on each side of the order book. This would enable you to capture the difference between your bid/offer prices as the price ticks up and down.

How to Choose a Market Making Bot

When choosing a crypto trading bot that offers market-making functionalities, you need to look out for the following factors:

  • Reputation: First and foremost, ensure that the bot you want to use is reputable, high-quality trading software. Check (unbiased) user reviews on social media to get an impression of which bots to go for and which ones to avoid.
  • Security: If a trading bot has had prior security breaches or does not come with basic security features, it is better to choose a more secure provider.
  • Features: The more features a trading bot has, the better. If a bot does not offer stop-loss orders or does not have a user-friendly dashboard, for example, choose a different one.
  • Customizability: The more you can customize your market making bot, the better. Ensure you can adjust the bot’s settings sufficiently to execute your market making strategy.
  • Price: If a trading bot costs more than you think you can make given the amount of capital you have, then it is probably not worth the investment. Choose a bot that suits your wallet. Alternatively, you can also opt for the free, open-source option.

Popular crypto trading bots with market-making functionality include Haasbot, Hummingbot, Scavenger, and Tribeca, but there are many more out there.

How to Set up And Customize a Market Making Bot

While the setup and customization process will differ slightly from bot to bot, you will need to take the following steps to get your market-making bot up and running regardless of the trading software you use.

1. Sign up 

Once you have chosen a trading software to build your bot, register and log on. Some bots come with a subscription fee while others are free. Some are downloadable software, while others are web-based solutions. Choose what works best for you.

2. Choose a currency pair

The next step will be to choose a digital currency pair for which you want your bot to make markets. The key is to choose a liquid pair so that you can trade in larger sizes and, thus, potentially generate more trading income. BTC/USDT and ETH/USDT are the most likely candidates as bitcoin (BTC) and Ether (ETH) are the two largest digital currencies by market capitalization. If you are trading with less capital, you could also make markets in less liquid coins.

3. Choose the level of aggressiveness

The next step will be to choose how aggressive you want your bot to be. In the context of market-making, aggressiveness refers to how close to the mid-price you want your bot to buy and sell.

If you want to regularly be among the best bids and offers for BTC/USDC on Poloniex, for example, you will need to customize your bot to set its bid and offer orders at 0.1 percent away from the prevailing mid-price. With this level of aggressiveness, you would generate a high number of trades and generate small trading profits on each successful buy and sell transaction throughout the day.

4. Put risk management measures into place

Your chosen trading bot software will come with a number of risk management measures, such as stop-loss limits and other automatic fail-safes that can ensure that you will not incur significant losses during steep price drops or hikes. Risk management is a hugely important aspect of a market-making bot because sharp market movements on thinning volumes could cause your bot to lose money.

5. Backtest 

Most crypto trading bots offer a backtesting feature that enables you to test your trading strategy using historical prices. Backtesting allows you to see how well your market-making bot would have performed with your chosen parameters in the past. The more you backtest and fine-tune your bot, the better it will likely perform in the live markets.

6. Live test

Regardless of whether your bot comes with a backtesting function or not, it is best practice to also live test the bot once you have it set up. Only by testing your bot in the real world can you know if it will be profitable or not. The best way to live test the bot is to start with a small amount of capital to minimize potential losses.

7. Capitalize the bot

Once you are comfortable with your bot’s performance during the testing phases, you need to capitalize it so that it can execute more sizable orders to (potentially) generate a suitable trading profit.

Remember, the profit for market-making bots is equal to the profit per transaction multiplied by the volume traded. Hence, the larger each trade, the more money it is possible to make. However, the order sizes need to be in relation to the liquidity for the digital currency pair you are trading to ensure that you can get both sides of your trades filled.

8. Go Live

The next step will be to go live with the bot to see how your bot will fair in the real world.

9. Monitor the bot

Finally, you should monitor your bot’s performance. Even after successful backtesting and live testing, you should not lean back and wait for the profits to come in. It is vital to check in with your bot to see how it is performing and whether you need to tweak your bot’s settings or not.

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