Interest in Forex and Cryptocurrencies is increasing as each day passes by. However, some new investors and traders have a common question about these markets. They wonder how it is possible always to make a trade. Well, in the financial markets, market makers take care of this. Don’t worry if you don’t know what a market maker is. In this article, we will guide you through what a market maker is and what do they do.
So, What is a Market Maker?
As an investor and a member of the exchange, you want to buy shares, right? So, you have to find a place where to buy them. But who is that someone that will sell you those shares? Well, this is what market makers do. Market Makers across the global exchanges are there to provide liquidity for people at all times.
Moreover, stock exchanges, like, for example, the London and New York Stock Exchanges, encourage deals. As such, they need a continuous market running where people can sell or buy the shares listed on these exchanges. Also, there is a minimum size of shares that each exchange considers to be enough for the market to be liquid. In other words, there is a set volume of shares.
Furthermore, as the term “market makers” varies in different stock exchanges, we would like to share with you the following information. For example, in New York, they call them specialists. On the other hand, in the UK, these people are referred to as market makers. But what are market makers actually doing?
Understanding Market Makers
So, a market maker is there to provide liquidity for people at all times, right? Therefore, there are market makers in almost every market. Typically, market makers are big banks or brokerage houses. And as a vital part of the markets, market makers are retail investors. As such, you won’t deal with them directly. Generally, you need to go through a broker.
Further, market makers tend to work on behalf of large institutions. Also, they are obliged to be prepared to trade all day. In addition to this, each market maker has to display buy and sell quotations for a guaranteed number of shares. In fact, they need to continuously quote prices at which they will bid for or ask for. Also, they must quote the volume in which they are willing to trade.
Furthermore, to complete an order after it has been received, the market maker needs to sell off the bought number of shares from his own inventory. Moreover, places like the London Stock Exchange offer quotes between 8:00 AM and 4:30 PM. Of course, this means they make it possible for people to trade shares during this timeframe at the London Stock Exchange.
And as we said, market makers provide liquidity for investors and traders at all times. Of course, they must be compensated for the risk they take. So, how do they make money?
How do Market Makers Make Money?
Each market maker has a bid-offer price, and the gap between the bid and offer price is called spread. It is essential to know how these spreads and bid-offer prices are working. Moreover, as an investor, you need to know how to decipher them. So, let’s take a look at the following example.
The name of the shares you want to buy is “XYZ.” The bid price is 200p, and the offer price is 220p. The gap between these two, or the spread, equals 20p. Also, the mid-price is 210 p. As some people often confuse the bid and the offer price, let’s read through the definitions of these terms.
Bid Price is:
- The price that the market maker buys the shares at
- The price that the investor (you) is willing to sell at
Offer Price is:
- The price that the market maker sells the shares at
- The price that the investor (you) is willing to buy at
Generally, market makers aim to buy the shares at the lowest possible price and then sell them for a higher price. The wider the spread, the bigger the profit for the market maker. However, on the other hand, the more market makers there are competing for these shares, the narrower the spread. In other words, there will be less profit for the market maker.
Market Maker Traps
You need to watch out for trap when buying and selling shares. Not every market maker has pure intentions. For example, some of them will only show you the mid-market price. So, make sure you always ask for the spread. The more informed you are, the better. Also, if you have decided to buy “unpopular shares, then you need to watch out for the spreads. They tend to widen against you.