Market Maker – Definition, Role, How They Work

Market makers play a crucial role in maintaining liquidity and efficiency in financial markets. By continuously quoting buy and sell prices for securities, they ensure that investors can transact without significant price delays or gaps. Whether in stock exchanges or currency markets, market makers help reduce volatility and provide smoother execution of trades. Understanding what they do and how they operate can give investors valuable insights into the inner workings of the market.

A market maker is a financial intermediary or brokerage firm that continuously provides buy and sell quotes for a particular security, thereby ensuring that trading in that security remains active.

• They stand ready to buy and sell at publicly quoted prices.
  

• Market makers earn a spread, which is the difference between the bid price (buying price) and the ask price (selling price).

Market makers are the backbone of market liquidity. Their responsibilities include:

Providing Liquidity

Market makers continuously quote buy and sell prices for securities, ensuring that investors can enter or exit positions without waiting for counterparties. This consistent availability supports active trading and reduces the risk of illiquid markets.

Stabilising Prices

By absorbing excess buying or selling pressure, market makers help reduce sharp price swings. Their activity creates a buffer against extreme volatility, promoting a more orderly market environment.

Facilitating Smooth Trading

Market makers enable quicker trade execution by standing ready to buy or sell when other investors are not immediately available. This efficiency minimises delays and enhances the overall trading experience for participants.

Enhancing Market Efficiency

Through continuous participation, market makers help ensure that security prices reflect the current balance of supply and demand. This improves price discovery, making the market more transparent and efficient for all investors.

Understanding the functioning of market makers helps investors know how liquidity is maintained:

• They quote two prices for each security:
  

  • Bid Price: The price at which they will buy.
    

  • Ask Price: The price at which they will sell.
    

• They earn the bid-ask spread as compensation for providing liquidity.
  

• They maintain inventory of securities to fulfill buy and sell requests quickly.
  

• Their activity is regulated by exchanges to prevent price manipulation.

Consider a stock trading at ₹100. A market maker may:

• Quote a bid price of ₹99.90.
  

• Quote an ask price of ₹100.10.
  

• When an investor sells at ₹99.90 or buys at ₹100.10, the market maker earns the ₹0.20 spread per share.
  

This constant activity ensures that trading remains uninterrupted, even in times of high volatility.

Market makers are crucial to both retail and institutional participants because:

• Reduces Price Gaps: Investors can execute trades quickly without large price deviations.
  

• Supports Liquidity in Low-Volume Stocks: Ensures small-cap or less-traded stocks remain tradable.
  

• Builds Investor Confidence: Encourages participation by ensuring that markets remain active and efficient.

Market makers are the silent facilitators of stock markets, maintaining liquidity, minimising volatility, and enabling efficient trading. By consistently providing buy and sell quotes, they help ensure that investors can transact smoothly at fair prices.

This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.