What is a Market Maker?
A market maker refers to a firm or individual who actively quotes two-sided markets in a particular security by providing bids and offers (known as asks) along with the market size of each. Market makers provide liquidity and depth to markets and profit from the difference in the bid-ask spread. They may also make trades for their own accounts, which are known as principal trades.
Key Takeaways
- A market maker is an individual participant or member firm of an exchange that buys and sells securities for its own account.
- Market makers provide the market with liquidity and depth while profiting from the difference in the bid-ask spread.
- Brokerage houses are the most common types of market makers, providing purchase and sale solutions for investors.
- Market makers are compensated for the risk of holding assets because a security’s value may decline between its purchase and sale to another buyer.
- While brokers compete against one another, specialists post bids and asks and ensure they are reported accurately.
Understanding Market Makers
Many market makers are often brokerage houses that provide trading services for investors in an effort to keep financial markets liquid. A market maker can also be an individual trader, who is commonly known as a local. The vast majority of market makers work on behalf of large institutions due to the size of securities needed to facilitate the volume of purchases and sales. Each market maker displays buy and sell quotations for a guaranteed number of shares. Once the market maker receives an order from a buyer, they immediately sell off their position of shares from their own inventory. This allows them to complete the order.
A market maker must commit to continuously quoting prices at which it will buy (bid for) and sell (ask for) securities. Market makers must also quote the volume in which they’re willing to trade along with the frequency of time they will quote at the best bid and best offer prices. Market makers must stick to these parameters at all times and during all market outlooks. When markets become erratic or volatile, market makers must remain disciplined in order to continue facilitating smooth transactions.
How Market Makers Earn Profits
Market makers are compensated for the risk of holding assets because they may see a decline in the value of a security after it has been purchased from a seller and before it’s sold to a buyer. Consequently, they commonly charge the aforementioned spread on each security they cover. For example, when an investor searches for a stock using an online brokerage firm, it might observe a bid price of $100 and an ask price of $100.05. This means the broker purchases the stock for $100, then sells it to prospective buyers for $100.05. Through high-volume trading, a small spread can add up to large daily profits.
Market Makers vs. Designated Market Makers (DMMs)
Many exchanges use a system of market makers, who compete to set the best bid or offer so they can win the business of incoming orders. But some entities, such as the New York Stock Exchange (NYSE), have what’s called a designated market maker (DMM) system instead. DMMs are essentially lone market makers with a monopoly over the order flow in a particular security or securities. The specialist posts these bids and asks for the entire market to see and ensures they are reported in an accurate and timely manner. They also ensure that the best price is always maintained, that all marketable trades are executed, and that order is maintained.
Market Makers by Exchange
Market makers provide trading services for investors who participate in the securities market. Their activities through their entity trading accounts produce and boost liquidity within the markets. You can find these entities all over the global market. We’ve highlighted some of the most popular ones in different parts of the world.
NYSE and Nasdaq
The NYSE and NASDAQ are the two main stock exchanges in the United States. Market makers here include:
- Credit Suisse
- Deutsche Bank
- Goldman Sachs
- KCG Americas
- Timber Hill
Frankfurt Stock Exchange (FRA)
Also known as the largest in Germany, the Frankfurt Stock Exchange calls its market makers designated sponsors, which include:
- Berenberg
- JPMorgan
- Morgan Stanley
- Optiver
- UBS Europe
London Stock Exchange Group
London Stock Exchange, part of London Stock Exchange Group, lists its key market makers as:
- BNP Paribas
- GMP Securities Europe
- Liberium Capital
- Mediobanca
- Standard Chartered
Tokyo Exchange Group
The Tokyo Exchange Group merged the Tokyo Stock Exchange and the Osaka Securities Exchange. Major market makers here include:
- ABN AMRO Clearing
- Nissan Securities
- Nomura Securities
- Phillip Securities
- Societe Generale
Toronto Stock Exchange (TSX)
The major market maker names on TSX include:
- BMO Nesbitt Burns
- Integral Wealth Solutions
- Questrade
- Scotia Capital
- TD Securities
Example of a Market Maker
Here’s a hypothetical example to show how a market maker trades. Let’s say there’s a market maker in XYZ stock. They may provide a quote of $10.00 - $10.05 or 100x500. This means that they make a bid (they will buy) of $10.00 for 100 shares. They’ll also offer (they will sell) 500 shares at $10.05. Other market participants may then buy (lift the offer) from them at $10.05 or sell to them (hit the bid) at $10.00.
Who Are Market Makers and What Do They Do?
A market maker participates in the securities market by providing trading services for investors and boosting liquidity in the market. They specifically provide bids and offers for a particular security in addition to its market size. Market makers typically work for large brokerage houses that profit off of the difference between the bid and ask spread.
How Do Market Makers Work?
A number of market makers operate and compete with each other within securities exchanges to attract the business of investors by setting the most competitive bid and ask offers. In some cases, exchanges like the NYSE use a specialist system where a specialist is the sole market maker who makes all the bids and asks that are visible to the market. This specialist process ensures that all marketable trades are executed at a fair price in a timely manner.
How Do Market Makers Earn a Profit?
Market makers earn a profit through the spread between the securities bid and offer price. Because market makers bear the risk of covering a given security, which may drop in price, they are compensated for this risk of holding the assets. For example, consider an investor who sees that Apple stock has a bid price of $50 and an ask price of $50.10. This means the market maker bought the Apple shares for $50 and is selling them for $50.10, earning a profit of $0.10.
The Bottom Line
The market is made up of a range of different entities that help keep things going. They include corporations, exchanges, traders and investors, and market makers. Each one of these serves a different purpose: Companies offer their shares on the market. Exchanges are where these transactions take place, traders and investors are at one end of the transactions, and market makers play a crucial role by injecting much-needed liquidity through their bids and offers into the markets.
Related Terms: bid-ask spread, broker-dealer, trading, securities.
References
- U.S. Securities and Exchange Commission. “Fast Answers: Market Makers”.
- U.S. Securities and Exchange Commission. “Trade Execution: Rules Your Brokerage Firm Must Follow”.
- U.S. Securities and Exchange Commission. “Specialists”.
- Nasdaq. “Specialist”.
- The World Bank. “Market capitalization of listed domestic companies (current US$) - United States”.
- NYSE. “Market Makers”.
- Nasdaq Trader. “How to Become a Market Maker”.
- Börse Frankfurt. “Designated Sponsor”.
- Xetra. “List of Designated Sponsors”.
- LSEG. “About Us”.
- Financial Conduct Authority. “List of market makers and authorised primary dealers using the exemption under the UK version of Regulation (EU) No 236/2012 of the European Parliament and of the Council of 14 March 2012 on short selling and certain aspects of credit default swaps”.
- Japan Exchange Group. “About JPX”.
- Japan Exchange Group. “List of Market Makers”.
- TMX. “Market Makers List”.
