Market Maker

Loading the player...

What is a 'Market Maker'

A market maker is a broker-dealer firm that assumes the risk of holding a certain number of shares of a particular security in order to facilitate the trading of that security. Each market maker competes for customer order flow by displaying buy and sell quotations for a guaranteed number of shares, and once an order is received from a buyer, the market maker immediately sells from its own inventory or seeks an offsetting order. The Nasdaq is the prime example of an operation of market makers, given that there are more than 500 member firms that act as Nasdaq market makers, keeping the financial markets running efficiently.

BREAKING DOWN 'Market Maker'

The most common type of market maker is a brokerage house that provides purchase and sale solutions for investors in order to keep the financial markets liquid. A market maker can also be an individual intermediary, but due to the size of securities needed to facilitate the volume of purchases and sales, almost all market makers are large institutions.

How Market Makers Facilitate Financial Transactions

Market makers hold large volumes of a security and can fulfill a large amount of orders in the financial markets. These orders are purchases and sales and happen in a matter of seconds. A good example of a market maker is a standard online brokerage firm such as Charles Schwab or Merrill Lynch that can fill security orders quickly and efficiently.

Essentially, market makers are always taking the opposite side of investor trading volume. If investors are looking to sell a security, for example, market makers continue to purchase that security until all sellers are satisfied. Conversely, if investors are buying a security, market makers continue to sell that security until all orders are filled. Market makers, therefore, satisfy the supply and demand of the financial markets and keep securities changing hands from sellers to buyers, and vice versa.

How Market Makers Earn Profits

All market makers are compensated for the risk of holding assets. The risk they face is a decline in the value of a security after it has been purchased from a seller and before it's sold to a buyer. Therefore, market makers charge a spread on each security that they cover. This is known as the bid-ask spread and is extremely common in financial transactions. For example, when an investor searches for a stock using an online brokerage firm, it might have an ask price of $100 and a bid price of $100.05. This means that the broker is purchasing the stock for $100 and then selling the stock for $100.05 to prospective buyers. Through high-volume trading, the small spread ads up to large daily profits.

RELATED TERMS
  1. Third Market Maker

    A third-party securities dealer that is ready and willing to ...
  2. Indicative Quote

    In forex trading, a currency quote that is provided by a market ...
  3. Bid

    1. An offer made by an investor, a trader or a dealer to buy ...
  4. Level 2

    A trading service consisting of real-time access to the quotations ...
  5. Trade Or Fade Rule

    An options exchange rule that requires the market maker to either ...
  6. Normal Market Size

    A share classification structure based on the number of shares ...
Related Articles
  1. Investing Basics

    Role Of A Market Maker

    A market maker is a firm or an individual that stands ready to buy and sell a particular security throughout the trading session to maintain liquidity and a fair and orderly market in that security. ...
  2. Professionals

    How Brokers Can Avoid A Market-Maker's Tricks

    Ensure that you and your clients are getting the best deal by avoiding these three pitfalls.
  3. Forex Education

    Market Makers Vs. Electronic Communications Networks

    Learn the pros and cons of trading forex through these two types of brokers.
  4. Investing Basics

    What's a Dealer Market?

    In a dealer market, market participants buy and sell through dealers who are designated as market makers.
  5. Investing Basics

    What Happens in a Haircut?

    One meaning of haircut is the difference between prices at which a market maker can buy and sell a security.
  6. Brokers

    Explaining Market Orders

    A market order is the most common order used to purchase a financial security.
  7. Investing Basics

    Designated Market Maker

    A designated market maker maintains fair and orderly markets for an assigned set of listed firms and improves market liquidity.
  8. Investing Basics

    Understanding Order Execution

    Find out the various ways in which a broker can fill an order, which can affect costs.
  9. Investing Basics

    The Basics Of The Bid-Ask Spread

    The bid-ask spread is essentially a negotiation in progress. To be successful, traders must be willing to take a stand and walk away in the bid-ask process through limit orders.
  10. Options & Futures

    How To Avoid Closing Options Below Intrinsic Value

    To get the best return possible on your options trading, it is important to understand how options work and the markets in which they trade.
RELATED FAQS
  1. What is the difference between a broker and a market maker?

    A broker is an intermediary who has a license to buy and sell securities on a client's behalf. Stockbrokers coordinate contracts ... Read Answer >>
  2. Is an earnings surprise priced into the opening value by market makers or does the ...

    An earnings surprise is an event where the earnings of a company are greater or lower than the predictions put forth by analysts, ... Read Answer >>
  3. What is the difference between a quote driven market and an order driven one?

    The difference between these two market systems lies in what is displayed in the market in terms of orders and bid and ask ... Read Answer >>
  4. What's the difference between a Nasdaq market maker and a NYSE specialist?

    What's the main difference between a specialist and a market maker? Not much. Both the New York Stock Exchange (NYSE) specialist ... Read Answer >>
  5. Does a broker always have to buy a stock if I want to sell it?

    There are certain times when a broker must purchase the stock that you are selling. For example, if the broker is a market ... Read Answer >>
  6. How do I buy an over-the-counter stock?

    The process of purchasing over-the-counter (OTC) stocks is different than purchasing stock from companies on the NYSE and ... Read Answer >>
Hot Definitions
  1. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  2. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
  3. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
  4. Basis Point (BPS)

    A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly ...
  5. Sharing Economy

    An economic model in which individuals are able to borrow or rent assets owned by someone else.
  6. Unlevered Beta

    A type of metric that compares the risk of an unlevered company to the risk of the market. The unlevered beta is the beta ...
Trading Center