A market maker is a firm or individual that stands ready to buy or sell a security. Investors may take the ability to buy and sell securities whenever they want for granted. Remember that every time you buy or sell an investment, there's another party on the other end of that trade. That party is often a market maker.
The market maker will offer up-to-date prices at which they're willing to buy or sell and the amounts of the security it's willing to buy or sell at those prices. Let's dive into how market makers operate, why they're important to the stock market, and how they make money.
Understanding market makers
Market makers are usually banks or brokerage companies that provide trading services. By making a market for securities, these banks and brokerages enable much greater trading activity and use of their services.
Market makers usually carry an inventory of any securities they make a market in. Additionally, they're constantly offering quotes on prices they're willing to pay to buy more shares (a bid price) and the price they're willing to sell their shares for (an ask price). The difference between the buy and sell quotes is called the bid-ask spread.
When a market maker receives a buy order, it will immediately sell shares from its inventory at its quoted price to fulfill the order. If it receives a sell order, it buys shares at its quoted price and adds them to its inventory. It will take either side of a trade, even if it doesn't have the other side lined up right away to complete the transaction.
Market makers are regulated by the exchange they operate on, as well as any financial industry regulators in the country they're based in since they operate as broker-dealers. Exchanges in the United States are governed by the U.S. Securities and Exchange Commission (SEC). Broker-dealers must also register with FINRA.
Market makers in different markets and operating on different exchanges are subject to different rules regarding what they're allowed to buy and sell and the types of trades they can make.
The importance of market makers
Market makers are essential to enable the financial markets to operate smoothly and to fill market orders big and small. Anytime you invest in stocks, someone is on the other end of your trade, and it could be a market maker.
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