A market maker (MM) is a company or entity that actively quotes two-sided markets in a defense, providing bids and offers (known as asks) along with the size of each market. A market maker in XYZ stock, for example, might provide a quote of $10.00-$10.05, 100×500. This means they bid (they will buy) 100 shares for $10.00, and offer (they will sell) 500 shares for $10.05 as well.
Other market participants can then purchase (lift the offer) $10.05 from the MM or sell (hit the bid) $10.00 to them. Market makers provide market liquidity and depth, and profit from the bid-ask spread difference. Market makers may also do business with their own accounts. In other words, it is the key trades.
Understanding Market Makers
Many market makers are often brokerage houses. It provides investors with trading services in an effort to keep financial markets liquid. A market maker may also be an individual trader or local. But, the vast majority of market makers work on behalf of large institutions because of the size of securities needed to facilitate the volume of purchases and sales.
A market maker must commit to quoting the rates at which it will purchase (or bid for) and sell (or ask for) securities continuously.
Market makers will have to quote the amount they are willing to trade in. And also, the duration of time it will quote at the Best Bid and Best Offer (BBO) rates. They must always stick to these criteria, across all business outlooks. In order to continue promoting smooth transactions, they need to remain vigilant when markets are chaotic or unpredictable.
How Market Makers Earn Profits
Market makers are compensated for the risk of holding assets. Because of the purchased from a seller and before being sold to a buyer, they may see a decline. It is in the form of the value of a security.
Consequently, the aforementioned spread is usually paid to them for each coverage they protect. For example, when an investor uses an online brokerage company to search for a stock, it may find a $100 bid price and an ask price of $100.05. That means the broker buys the stock for $100, and then sells it for $100.05 to prospective buyers. Small spreads add up to big daily profits by high-volume trading.
