Glossary
Market maker
A firm that continuously quotes both a bid and an ask in a security, providing liquidity and earning the spread.
A market maker is a firm that stands ready to buy and sell a security throughout the day, quoting a price at which it will buy (the bid) and a slightly higher price at which it will sell (the ask). By being on both sides, it lets other investors trade immediately even when no natural buyer or seller is present. In return it hopes to earn the difference between the two prices, the bid-ask spread.
How a market maker earns, and loses
That second case is the business's central risk, called adverse selection: the traders most eager to trade with you often know something you don't. Market makers manage it by widening spreads when volatility rises, keeping inventories small and hedging with related securities.
Kinds of market makers in the US
- Exchange market makers register with an exchange and must keep two-sided quotes within set ranges. The NYSE also assigns a designated market maker (DMM) to each listed stock to help run the opening and closing auctions.
- Wholesalers buy most retail stock orders from brokers, often paying for that order flow, and fill them off-exchange, frequently at or better than the national best bid and offer.
- Options market makers quote thousands of strikes and expirations and hedge with the underlying stock.