financial markets have appointed specialists or market makers to keep orderly markets and continually supply liquidity in traded securities. For many years, these individuals played a key role in determining prices and participated in a large fraction of trading. Today, this is no longer the case. Over the past decade, the task of liquidity provision has largely shifted from traditional market makers to proprietary automated systems that trade at high-frequency and across different exchanges and securities.

What is Market Making?

Market making help ensure the liquidity of a market by offering to both buy and sell securities. A market maker is a trader whose primary job is to create liquidity in the market by buying and selling securities. Market makers are always ready to buy and sell within the market at a publicly-quoted price.

As the name suggests, market makers “create the market.” In other words, they create liquidity in the market by being readily available to buy and sell securities. This creates liquidity within the market. Most importantly, it helps other trades occur smoothly. Without market makers, the market would be relatively illiquid, which would prohibit the ease of trades.

Here’s how it works: When you sell 5,000 shares of a particular stock, a market maker will purchase it from you at what’s called the bid price. Then, they’ll turn around and sell it to a buyer at the ask price. Market makers can then sell these purchased securities to broker-dealer firms within their exchange. Keep in mind that when market makers purchase securities, they don’t always have a buyer lined up right away

Market Making strategy

As soon as an order is received from a buyer, the Market Maker sells the shares from its own inventory and completes the order. And, this process increases the liquidity in the market. Hence, it is known as Market Making Strategy. A good market making strategy is nothing more than planning ahead on how you will react to market changes.

Why is Market Making important?

market makers help financial markets by maintaining the efficiency of their operations. This makes market making really important for financial markets. If we take out market makers, there would not be many transactions taking place in the market. This is the reason that market makers have been an integral part of market infrastructure.

Algorithmic Market making and its benefits

Made markets less volatile
Reduce indirect costs paid as bid-ask spreads
Efficiently priced markets
Increased liquidity across the board
Reduce impact cost (while trading big sizes)

While using automated systems for Market Making, you get:

Faster response time for Market Making
Scalability for Market Making
24×7 Availability for Market Making

The Bottom Line

A market maker plays an important role in the financial markets. They are readily available to buy and sell securities, thus creating liquidity in the market. Without market makers, the market would be relatively illiquid and other trades would be impacted. With Market Making not only create the market, but also earn profit by selling at a slightly higher price than the market price.