What is a market maker?

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How do they make profit? Can any financial firm become a market maker? Can an individual be a market maker?

In: Economics

3 Answers

Anonymous 0 Comments

A market maker is basically some agent that facilitates purchases between other parties in the market, making money on a difference in the price at which the maker purchases something and which they then sell it to another party (at a basic level, it can be simple arbitrage; it can also involve a market maker taking a commission, or some fee based on the price of the sale, for the service).

The market maker provides public prices at which it will buy and sell a given commodity or financial product, providing a way for producers to liquidate their products and buyers to acquire those products easily.

An individual *could* be a market maker, but this kind of business model tends to require a relatively large amount of capital for the continuous operation that underpins the role; thus it is typical for market makers to be backed by some larger collective institution so that they can operate smoothly.

Anonymous 0 Comments

Market makers bring together enough buyers and sellers to create a working market. This can involve a few possible activities:

1) Recognizing the need for a new market. This could be noticing the rise of a new good or service (like all the crypto exchanges that popped up during that boom) or inventing a new good that people might want to trade (like a financial derivative).

2) Reducing transaction costs: Maybe this is something people have already traded for a while, but you’ve found a way to make it easier to trade. You could argue that this is what Uber and Lyft have done by linking drivers and people who need a ride through an easy-to-use app.

3) Building networks: For very thin or rarified markets (like art or antiquities), knowing everyone who might want to buy (or sell) the good means you’re the one everyone turns to when they want to make a transaction.

Market makers collect their money as a commission from the people who use their markets. This is usually a pretty easy sell because you’re talking about people realing gains from a trade that they wouldn’t have made without your help. Even if you collect some of that surplus, buyers/sellers still prefer trading through your mechanism to not trading at all.

Whether a single person can be a market maker depends on the market. As noted above, sometimes market makers are just THE person to talk to about buying/selling a particular rare object. For bigger markets, you probably need a more complex/robust organization to manage all the trade.

Anonymous 0 Comments

The other answers seem to be approaching the point but let me add my .02: Market makers don’t create markets (that’s what exchanges do), but they make the markets viable. What does this mean? Well, basically, lets say there’s a bad day in the oil markets and you’re a commodities market maker. Well you would, in that scenario, buy the oil nobody wants. You *make the market* viable by creating liquidity. That’s what keeps bid-ask spreads tight. This is why trades can go through and why there seems to always be a buyer (on popular products at least). You know/hope that the prices will go up and you make your money back. This is like your everyday trading but MM hedge (balance the risk) by 1) buying similar products (maybe it was crude oil that was taking a hit and they’d buy natural gas? Idk I’m not a MM). In options this means buying something with the same expiration on the same underlying, but with a step up or down in strike. And 2) doing it on a HUGE scale. So basically MM is just a strategy which actually helps everybody. Since they profit on the bid/ask spread, they basically make a tiny bit of money in exchange for making the market more efficient.

Can you be a market maker? I don’t know, how much money and experience do you have? In theory, anybody can become a MM, but there are requirements which vary by exchange. Plus, you need a ton of infrastructure and data to do it properly in modern times. Usually market makers operate on certain exchanges, but not all of them. For example, here are the requirements to be a MM on NYSE ARCA: https://www.nyse.com/markets/nyse-arca/market-making