Market maker definition

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What is market maker?

A market maker is a market participant that buys and sells large amounts of a particular asset in order to facilitate liquidity and ensure the smooth running of financial markets. An individual can be a market maker, but due to the quantity of each asset needed to enable the required volume of trading, a market maker is more commonly a large institution.

Market makers will have a certain amount of the asset (or assets) that they deal in. By displaying a buy and sell quote and executing trades at those prices rapidly, market makers can create a straightforward way to place trades.

They are most common in share trading but can also act in other markets. If we take the stock market, a market maker can only sell the number of shares that they can acquire themselves. However, they are obliged to meet the Normal Market Size (NMS) – the minimum number of securities – which can vary from share to share. IG uses market makers for the pricing of some illiquid shares.

The meaning of market maker comes from the practice of setting market prices at levels needed for supply and demand to find balance. When markets become volatile, market makers have to remain stable and continue to be responsible for market performance, which opens them up to a large amount of risk. This is why market makers make their money by maintaining a spread on the assets that they enable you to trade, to compensate for the risk of buying an asset that may devalue.

Example of a market maker

A market maker may offer to purchase 100 shares from you at $100 each (the ask price), and then offer to sell them to a buyer at $100.05 (the bid price). Though this is only a $0.05 difference, in high-volume trading, the profits will soon add up.

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