What is a Market Maker?

A market maker is a person or entity that provides liquidity to financial markets by continuously buying and selling a particular asset at publicly quoted prices.

They “make a market” by always being ready and willing to trade.

They quote two prices

A Bid

The price at which they are willing to buy a security.

An Ask

The price at which they are willing to sell.

The Spread

The spread is the difference between those two prices. This is how market makers turn profit.

If a market maker quotes a bid of $99.95 and an ask of $100.15 for a share of stock, they will buy shares from anyone who wants to sell at $99.95 and sell to anyone who wants to buy at $100.15 making $0.20 per share on the transaction. Now, this may not sound like much, but imagine how the numbers work at a very large scale.

Their Risk

Market makers are putting these stock positions on their books for a period of time. If the marketable value of the stock significantly declines and there is no interest on the buy side, they will take a financial loss on the decrease in the value of a stock that they cannot sell.

Essential Because:

By providing this service, market makers ensure that investors can buy or sell a security quickly without having to wait for another individual investor to show up on the other side of a trade.

Imagine you wish to sell 100 shares of stock, but instead of being able to sell to a market maker immediately, you must call Aunt Hazel and see if she is interested in buying your stock. Now you need to go and get coffee, exchange pleasantries, and sign over your stock certificate. Clearly this is slow and inefficient. Also, why would you sell this dog of a stock to your aunt? Have you no shame?


Besides, Aunt Hazel is playing pickleball and does not want your stock to begin with.


Thank goodness there are people on Wall Street who are willing to make a market and ensure immediate liquidity.

-Zac

Photo: Lynn Barr