A market maker, sometimes abbreviated to mm, is a company or person who quotes two-sided markets for a financial instrument, providing bids and offers. This term came from fixing market prices at levels needed for supply and demand to work harmoniously. To manage their risk and to generate a steady income, market makers add a spread to the financial assets that they provide their traders with.
Without market makers (usually banks or brokerage firms), it would be significantly harder and would take much longer for buyers and sellers to be paired with each other. It would also mean market liquidity would be reduced, making it more expensive and more difficult for traders to enter or exit positions.
Market makers generally hold a large number of a given financial product to cope with a high volume of market orders in a short period and at competitive prices. If investors sell, market makers generally keep buying, and vice versa. Market makers take the opposite side of whatever trades are being conducted at any given point in time.
Example of a market maker
A market maker purchases 100 apple shares at $100 each (the asking price). They decide to sell these to a buyer at $100.05 (the bid price). Though there is only a $0.05 difference, when the volumes are big, profits soon add up.
Key takeaways:
- Market makers ensure there is always a two-sided market where participants can buy and sell more easily and provide a liquid market at all times
- Marker makers take on a relatively high level of risk because of the large number of units they hold, which we could also call their “inventory”
- Market makers quote both the buy and sell prices of a product in the hope of getting investors to trade it