Who it's for — Anyone who thinks that when they buy a stock, there's always another small trader on the other side of the world ready to sell it to them. Wrong. You are often buying from the House (the Dealer).
A Market Maker is a financial institution (a bank, a fund, or a high-frequency trading algorithm) that commits to continuously buying and selling an asset, guaranteeing the market's Liquidity.
Without Market Makers, if you wanted to sell your 10 Apple shares at $150, you would have to wait for another human trader to decide to buy them at exactly that moment and at that price. The market would be incredibly slow and clogged.
In simple terms — Imagine a currency exchange booth at the airport. If you have Dollars and want Euros, you don't look for an American tourist willing to swap with you. You go to the booth: they have a cash register full of both currencies and execute the trade instantly. The currency booth is a Market Maker.
How does a Market Maker make money? (The Spread)
The Market Maker does not bet on the direction of the market. They don't care if Apple goes up or down. Their only goal is to collect the Bid-Ask Spread.
The Market Maker always quotes two prices:
- Bid: The price at which they are willing to buy from you (e.g., $99.99).
- Ask: The price at which they are willing to sell to you (e.g., $100.01).
Every time they act as a middleman between a buyer and a seller, they pocket the difference (in this case, $0.02). They do this millions of times a day.
The Myth of "Stop Loss Hunting"
Many frustrated retail traders believe that Market Makers "manipulate" the price to hunt down their small Stop Losses.
The truth is much more cynical: the Market Maker has no personal vendetta against you. Their goal is to accumulate or offload enormous quantities of assets without blowing up the market. To do this, they need liquidity. And where is the liquidity located? Exactly where all the small retail traders have placed their Stop Losses (below supports and above resistances). The price is drawn to those areas simply because that's where the "oxygen" (orders) the large operator needs to breathe is found.
Summary Sheet
- What it is: An entity that constantly displays buy and sell quotes to guarantee liquidity.
- Its profit: The Spread (the difference between Bid and Ask).
- Its risk: Getting "stuck" holding too much inventory during a sudden market crash (Flash Crash).
Bronze Path — Module 1: What is a market. Next lesson: Exchange and Broker. Return to index: bronze-path.
Links
- bid-ask-spread — The Market Maker's profit margin.
- liquidity — The vital service offered by Market Makers.
- exchange-and-broker — The difference between the direct market and the retail intermediary.
- bronze-path
Module: Module 1 — What is a market
Understand that the market is not a line going up and down, but a place where exchange happens.
