What are Market Makers?

Good morning,


Rather conveniently, answering this question also answers the question of "Why can most people always be able to trade in financial markets?" - selling shares is not the same as selling your house, which can take forever depending on what price you're asking for it.


In effect, the job of market makers is to provide liquidity (the ability to buy and sell) and you'll find them in basically every market (currencies and bonds, etc). The big point about the stock market though is that the exchanges want to encourage as much trading as possible and thus want a market continuously running.


Generally speaking large banks and one or two hefty brokerage firms will have teams who act as market makers (primary traders).


Now, market makers make money though the bid/offer spreads, with larger spreads meaning more profit for the market maker. Incidentally, stocks that have more market makers in a particular stock will usually have smaller spreads and market makers are technically obliged to give two-way prices at all times:


e.g.


Bid = 10p

Offer/Ask =12p


Spread = 2p or 20%


Bid: This is the price you sell at to the market maker (the price they buy from you at).

Offer/Ask: This is the price you buy at from the market maker (the price they sell to you at).


If you get confused as to which price you buy and sell at, remember that the market maker's job is to screw you over for as much money as possible, which should remind you that you buy shares at the offer/ask (the higher price) and sell at the bid (the lower price).


Most market making in terms of daily volume on exchanges is actually done by electronic market makers, which are then overseen by primary traders, like the SETS system that runs on the London Stock Exchange and is effectively an electronic order book for the share you want to trade in.


This has a rather cool link to high frequency trading (HFT), because automatic market makers exist within the HTF market to try and get the highest price available from someone looking to buy shares:


e.g. I want to buy 1000 shares in BP at 440p.


Now, I could show my hand and just put that into the electronic order book, or I could get an algorithm to split that order up into groups of 100 shares, with a cap to not buy at a price above 440p.


In the next step, the Automatic Market Maker starts to realise that these 100 share buy orders are coming in and try to take advantage of this, so it starts to ping out orders in descending ask prices and then immediately cancel them until something comes back positive.


When the order hits the 440p mark the Automatic Market Maker will come back with an ask price  that's been accepted. Then the Automatic Market Maker will go out and buy as many shares as possible, so to then sell these to me at 440p per share. Trying to buy shares, I can't then go anywhere else because the Automatic Market Maker has pulled all the shares towards itself within that price range, leaving me to purchase at 440p per share.


Thereby, the Automatic Market mMaker can manipulate the price of certain stocks to the upper range of an algorithms price strategy.


Have a great day,

The Masked Stock Trader