A market maker in the securities market, refers to a securities business entity with certain strength and credibility that acts as a licensed trader. They continuously quote both buying and selling prices (bid and ask prices) for specific securities to the public investors, and accept buy and sell orders from the public investors at those prices. Market makers use their own capital and securities to trade with investors. Through this continuous buying and selling, market makers maintain market liquidity and meet the investment needs of the public investors.
Functions of Market Maker
Providing Liquidity: By continuously quoting and trading, market makers ensure there are enough buyers and sellers in the market, allowing investors to buy and sell securities at reasonable prices at any time, thus enhancing market liquidity.
Narrowing Bid-Ask Spreads: Market makers, through competitive quoting, encourage the narrowing of bid-ask spreads, reducing transaction costs for investors.
Stabilizing Market Prices: During market fluctuations, market makers actively participate in trading to smooth out price volatility and maintain market stability. Market makers have a responsibility to participate in market making during sharp rises or falls in stock prices, which helps to curb excessive speculation and acts as a market "stabilizer." In addition, competition between market makers also largely ensures market stability.
Market makers primarily profit by earning the bid-ask spread (the difference between the buying price and the selling price). In addition, they can also generate income by holding securities and earning commissions.
Sources of profit for market makers
For example, suppose a market maker quotes a stock with a bid price of 10 yuan and an ask price of 10.1 USD.
If an investor wants to buy this stock, they can buy it from the market maker at 10.1 USD.
If an investor wants to sell this stock, they can sell it to the market maker at 10 USD.
The market maker earns a spread of 0.1 USD by taking on the counterparty risk of both buyers and sellers.
Market makers play a crucial role in the financial markets. They promote market activity and healthy development by providing liquidity, narrowing bid-ask spreads, and stabilizing market prices. They also improve market efficiency and transparency, reduce transaction costs for investors, and enhance investor confidence.
