Glossary · Funds and derivatives
Market maker
A market maker is a firm that is always ready to buy and to sell a stock or other security, quoting two prices, and earns the small gap between them.
Also called: market makers, liquidity provider, dealer, designated market maker, specialist
In plain words
A currency booth at the airport buys dollars from travelers at one price and sells them at a slightly higher one. It does not care which way the dollar goes; it earns the gap. A market maker does the same for stocks, bonds, options and ETFs, only electronically, millions of times a day.
It shows two prices at all times: the bid, what it will pay you, and the ask, what it will charge you. If a share is quoted $99.98 bid and $100.02 ask, you can sell at once for $99.98 or buy at once for $100.02. The difference, the spread, is the market maker’s pay.
Without market makers, a seller would have to wait for a buyer to show up at the same moment. With them, you can trade instantly: they provide liquidity.
Example
Pennies, many times over
- A market maker quotes a share at $99.98 bid, $100.02 ask.
- A seller sells it 1,000 shares at $99.98; minutes later a buyer buys 1,000 at $100.02. Gross profit: 1,000 × $0.04 = $40.
- Repeat that across thousands of stocks and millions of trades a day, and the pennies add up to a large business.
- The risk: if bad news hits after it buys at $99.98 and the price drops to $98, it loses $1,980 on those 1,000 shares.
Market makers earn small spreads on huge volumes and try to hold as little risk as possible, as briefly as possible.
One level deeper
On the New York Stock Exchange each stock has a designated market maker (once called a specialist), obliged to keep trading orderly. On Nasdaq many market makers compete in each stock. Most orders from small investors’ brokers in the US go to a few large wholesale market makers, which pay the brokers for the flow (payment for order flow) and fill the orders at or slightly better than the exchange’s best price.
Spreads show how easy a security is to trade. For the biggest US stocks and ETFs the spread is often a single cent; for small companies, far-out options or bonds that rarely trade it can be several percent. Spreads widen when markets are stressed, because market makers face more risk.
Market makers keep ETF prices close to the value of what the funds hold, and they hedge almost everything: an options market maker who sells you a call buys some shares to offset it. When they all hedge in the same direction, they can add to a move, as in a short squeeze.
Why it matters
They make it possible to buy or sell at once, at a fair price, which keeps trading cheap for everyone.
The spread is a real, if small, cost on every trade: trading often adds it up.
In a crash some market makers step back, spreads widen and prices can gap, as in the “flash crash” of May 2010.
A common mistake
Myth: Market makers bet against their customers.
In fact: Their business is the spread, not the direction of prices. They aim to buy and sell quickly and hedge what they hold. Their interest is that you trade, not that you lose.
Questions people ask
How do market makers make money?
Mainly from the bid-ask spread, buying slightly below and selling slightly above the market price, many times a day. Some also earn rebates from exchanges for posting quotes.
What is a bid-ask spread?
The gap between the highest price a buyer offers (bid) and the lowest price a seller asks (ask). A share quoted $99.98 / $100.02 has a $0.04 spread.
Are market makers the same as brokers?
No. A broker carries out orders for its clients; a market maker trades for its own account, on the other side of those orders. Some big firms do both.
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About the numbers
- This page explains a term. It is not investment advice.