What is a MARKET MAKER?

I've been looking through many videos online and can't find a simple explanation as to who market makers are and what exactly they do.

If I'm using Etrade to buy a stock, does Etrade then submit the order to Etrade's market maker? Or Are there a bunch of market makers assigned to just a few stocks? I'm lacking a concept of how the market makers, brokers, and traders all fit together. Are market makers independent contractors who are hired by brokers, and/or are they investment firms? I've watched basically all there is to watch on youtube about this, and would very much appreciate an elementary school level explanation as to these questions I posed. 

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  • 1 month ago
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    <<<I've been looking through many videos online and can't find a simple explanation as to who market makers are and what exactly they do.>>>

    Let me go back to the days before everything was handled electronically. 

    A market maker was a trader on the floor of an exchange who, among other things, was required to maintain an orderly market when possible. While the market was open the market maker was required to to have open orders to sell a set number of a certain security and to buy a set number of the same security. Usually there is a maximum difference in the price at which he is willing to buy and price at which he is willing to sell, although in a "fast market" he can increase the difference.

    This ensures that the average stock owner can be sure that if he submits a market order to his brokerage to trade a certain amount of a security that order will be filled.  The market maker makes sure a market exists for the security.

    Market makers may work for an investment bank or may be independent.

    <<<If I'm using Etrade to buy a stock, does Etrade then submit the order to Etrade's market maker?>>>

    Here is roughly the way it works. When you submit an order to Etrade to buy a stock first the brokerage checks to make sure the trade is allowed. If it is, the order is then submitted to a floor trader at the exchange hired by the brokerage. If the order can be filled immediately because the current ask quote is equal to or less than the limit price you specified it is filled immediately. If the order cannot be filled immediately because you specified a limit price lower than the lowest bid price currently in place you order is put entered into the "order book" and will be filled if the ask quote gets down to the price you specified. If the price you specified is higher than the highest current bid but lower than the lowest current ask the floor broker will go to the pit where the the stock is traded. and announce the order. If someone in the pit is willing to sell at the price you specified the order is filled. Otherwise the order is entered into the order book and becomes the new bid quote.

    <<<Are there a bunch of market makers assigned to just a few stocks?>>>

    Usually yes, but on the New York Stock Exchange it is normally a single specialist instead of a market maker.

    <<<I'm lacking a concept of how the market makers, brokers, and traders all fit together.>>>

    As a trader your you submit the order to a brokerage. The brokerage submits to order to the exchange. If necessary a floor trader at the exchange will take to order to trading pit where market makers will decide if they want to fill the order or not. If the market makers do not want to fill the order at that time it is entered into the order book.

    <<<Are market makers independent contractors who are hired by brokers, and/or are they investment firms?>>>

    Market makers may be hired by investment firms or they may be independents. They are not hired by brokerages.

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    You should be aware that there are qualifiers you may put on an order which may cause the order to be taken to the trading pit. For example, if you specify All or None (AON) the order at the current ask quote but the number of shares available at that price is less than the quantity you specified at the price the order will probably go the trading pit.

    You should also understand that market makers are free to change their prices at any time. For example, there have been multiple times I have seen market makers change their quotes based on an order I have submitted. For example if the bid quote is $1.00 and the ask quote is $1.25 and I submitted an order to buy at $1.05 I would not be surprised to see the bid quote change to $1.10 immediately. 

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