Market Maker
A market maker is a broker-dealer firm that stands ready to buy and sell a particular security at publicly quoted prices, providing liquidity to the market by maintaining bid and ask prices throughout the trading day.
Exam Tip
Market makers provide LIQUIDITY. Profit from bid-ask SPREAD. Must post TWO-SIDED quotes (bid and ask). Multiple makers compete.
What is a Market Maker?
A market maker is a firm that continuously quotes both buy (bid) and sell (ask) prices for securities, standing ready to execute trades at those prices. They provide liquidity and help ensure orderly markets.
How Market Makers Work
| Function | Description |
|---|---|
| Post Bid/Ask | Continuously quote prices to buy and sell |
| Provide Liquidity | Stand ready to trade when others want to |
| Profit from Spread | Earn the difference between bid and ask |
| Manage Inventory | Hold securities to facilitate trading |
Market Maker Obligations
| Obligation | Requirement |
|---|---|
| Two-Sided Quotes | Must post both bid and ask |
| Minimum Size | Must trade minimum quantities |
| Continuous Quotes | Must maintain quotes during market hours |
| Honor Quotes | Must execute at quoted prices |
How Market Makers Profit
| Source | Description |
|---|---|
| Bid-Ask Spread | Buy at $49.95, sell at $50.00 = $0.05 profit |
| Rebates | Exchanges pay for providing liquidity |
| Trading Activity | More trades = more spread capture |
| Position Management | Profit from inventory changes |
Market Maker vs. Specialist
| Feature | Market Maker (NASDAQ) | Specialist (NYSE - historical) |
|---|---|---|
| Competition | Multiple per stock | One per stock |
| Location | Electronic | Physical trading floor |
| Obligation | Firm-specific | Exchange-wide |
Types of Market Makers
| Type | Description |
|---|---|
| Wholesale | Execute retail broker orders |
| Institutional | Focus on large block trades |
| Options | Make markets in options |
| ETF | Create/redeem ETF shares |
Benefits to Markets
| Benefit | Explanation |
|---|---|
| Liquidity | Buyers and sellers can always trade |
| Narrower Spreads | Competition tightens bid-ask |
| Price Discovery | Continuous quotes aid price formation |
| Reduced Volatility | Absorb temporary imbalances |
Market Maker Risks
| Risk | Description |
|---|---|
| Inventory Risk | Holding securities that decline |
| Volatility Risk | Wide price swings during positions |
| Adverse Selection | Trading against informed traders |
| Competition | Multiple makers compress profits |
Regulation
| Regulation | Purpose |
|---|---|
| FINRA Rules | Conduct and quote requirements |
| SEC Regulation NMS | National market system rules |
| Exchange Rules | Exchange-specific requirements |
Exam Alert
Market makers provide LIQUIDITY by posting continuous bid/ask quotes. They profit from the SPREAD. Multiple market makers compete on NASDAQ. They're required to maintain two-sided quotes (bid AND ask).
Study This Term In
Related Terms
Bid-Ask Spread
SecuritiesThe bid-ask spread is the difference between the highest price a buyer is willing to pay (bid) and the lowest price a seller is willing to accept (ask), representing a transaction cost and liquidity indicator.
Liquidity
SecuritiesLiquidity refers to how quickly and easily an asset can be converted to cash without significantly affecting its price. Cash is the most liquid asset, while real estate and collectibles are considered illiquid.
Broker-Dealer
GeneralA broker-dealer is a financial firm that buys and sells securities for its customers (broker) and for its own account (dealer), regulated by FINRA and the SEC.