Many crypto investors have experienced a similar situation: a certain altcoin seems to be about to break out, and as soon as they buy in, the price immediately reverses downward, as if the market is “targeting your trades.” This phenomenon is especially common among small-cap coins, leading to the saying that they are “being targeted by market makers.”
But is this really the case? In fact, price reversals are not necessarily due to subjective manipulation but stem from the risk management behaviors of market makers under specific models.
The Crypto Club at Hong Kong University of Science and Technology (HKUST Crypto Club), led by President Dave, recently published a long post on X (account: @bc1qDave), systematically analyzing this long-standing market phenomenon that troubles retail investors from the perspective of market microstructure and quantitative models.
In the article, Dave points out that such price reversals are mostly not the so-called “market makers targeting retail investors” or subjective manipulation. Instead, they originate from market makers’ automated quoting adjustments based on the Avellaneda–Stoikov market-making model, considering inventory risk and toxic order flow. In other words, retail traders’ transactions often already alter the market’s risk pricing.
Market Makers Are Not Betting on Direction, They Are Managing Risk
Unlike typical investors, market makers do not profit from predicting price movements. Instead, they earn stable income through bid-ask spreads and quotes. Ideally, market makers maintain their inventory close to neutral, minimizing the impact of price fluctuations on overall PnL.
However, when the market experiences a large influx of buy or sell orders, this balance is disrupted.
You buy heavily
Equivalent to market makers selling heavily
Market maker inventory becomes “short exposure”
At this point, the inventory itself becomes a source of risk.
Mechanism 1｜Quote Skew: Why Do Prices Move in the Opposite Direction?
When market makers take on excessive short positions due to retail investors’ large buy orders, they have two core objectives:
Therefore, market makers will proactively lower their quotes to attract sell orders and suppress further buy orders. To investors, this behavior appears as “when I buy, the price drops.”
In reality, this is not targeted at individuals but the result of automatic quote adjustments in the system.
Mechanism 2｜Widening Spreads: Why Trading Becomes Difficult
If the inventory imbalance worsens further, market makers will also:
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Widen the bid-ask spread
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Reduce trading frequency
The purpose of this is to lower the risk undertaken per unit time and offset potential price losses through higher spreads.
The Core Concept Behind the Math: Reservation Price
In the market-making model, the actual transaction price for retail traders is called the Reservation Price, simplified as:
Reservation Price = Mid Price − γ × q
q: Market maker’s current inventory
γ (gamma): Risk aversion coefficient
When retail traders place concentrated orders, causing rapid inventory changes, the Reservation Price adjusts accordingly, influencing market quotes.
According to the Avellaneda–Stoikov model:
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The optimal quote revolves around the Reservation Price
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Inventory exhibits mean-reversion characteristics
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Spreads widen as risk increases
In simple terms: your trading flow changes the market’s risk pricing.
Why Are Retail Investors Especially Prone to “Water Reversal”?
Compared to institutional and professional traders, retail investors often have the following characteristics:
In highly liquid mainstream coins, these effects may be offset by other trading pairs; but in small altcoins, your orders are often the main market signals in a short period.
In other words, in small-cap markets, you are very likely to directly become the counterparty to market makers.
What Is the True Objective Function of Market Makers?
Rather than aiming to “beat up retail investors,” market makers pursue the maximization of:
- Spread profit − Inventory risk − Adverse selection risk
Among these, inventory risk is often incorporated as an “exponential penalty,” which explains why their quote adjustments are so swift and decisive.
Practical Tips for Retail Investors: Reverse Exploiting the Quote Mechanism
Once you understand the market makers’ quoting logic, you can also leverage it slightly.
For example, if you want to establish a 1000 USDT long position:
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Do not buy all at once
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Start with a small amount, e.g., 100 USDT
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Gradually add to your position as the quote system lowers prices
By entering in batches, your average cost basis is often lower than a single all-in buy.
To Be Continued | Toxic Order Flow Is the Other Half of the Truth
This article only reveals one reason for price divergence—inventory-driven quoting mechanisms. Another key factor is how market makers identify and defend against “toxic order flow.”
In the next article, Dave will delve into:
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How market makers analyze order books
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What types of trades are considered “toxic”
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The microstructure causes of certain extreme market events
This article, “Why Does Buying Altcoins Always Lead to Price Drops? Unveiling Market Maker Quoting Mechanisms—It’s Not ‘Market Makers Targeting You’,” originally appeared on Chain News ABMedia.
