Understanding the Role of the Market Maker
The stock market has many players that come together to perform essential functions for its overall success. One of those players is the market maker (MM). These entities play an important role in establishing liquidity. They can drive prices up and down, essentially “making the market”. Let’s dive deeper into the role they play, what they do, and what it takes to be an MM.
What are Market Makers?
An MM operates to make a profit, as do most entities on the stock market. These companies or individuals regularly buy and sell stock based on a publicly quoted price. The job is to provide liquidity that sets the buy and sell prices for stocks. These can be stocks they already hold or stocks they “make a market” in.
Typically, there are anywhere between 4-40 market makers on any given stock. Normally, they have an obligation to sell or buy at least 1,000 shares based on the advertised price. There are also some restrictions on what they offer to customers. Certain restrictions require them to offer the best sell and buy prices to prevent price gouging and excess volatility in what is supposed to be a reasonable and two-sided exchange.
How Do Market Makers Work?
Market makers work to make a profit. This is done by aiming to make money on the “spread”, or the difference between the bid and the ask (offer). An MM operates in the realm between the bid, which is the price they are willing to pay, and the ask, which is what the firm is willing to sell their shares at. In some cases, that can be a small window for profit. They are sometimes making thousands of trades a day in order to earn money.
An MM can receive orders from firms and earn a commission based on the orders they successfully fill. The orders typically involve purchasing or selling stock that helps a client become more liquid.
Who Can Be a Market Maker?
An MM can be either a firm or an individual. Stock market makers have to be willing to take risks. An order can be filled that doesn’t turn a profit. If this happens enough, the MM loses influence and possibly their job. At the same time, if you play it safe and don’t make enough moves, you also won’t turn a profit.
A market maker has to be someone who can handle many variables at once. This is so they can track bids and asking prices at all times. They must also track how stock positions are affecting their net capital. Sometimes, they are tracking bids and asks for more than 300 stocks at a time!
The Bottom Line
Market makers have a lot to gain – and lose – as they play the stock game. Their role is critical to the overall success of the stock exchange. Although Easy Stock Loans is not a broker, if you have any questions surrounding aspects of the stock market, we’re glad to discuss them over the phone.