A market maker is a firm or individual that provides liquidity by continuously quoting both buy (bid) and sell (ask) prices for a security. They stand ready to trade at any time, ensuring markets function smoothly. Market makers profit from the bid-ask spread while taking on the risk of holding inventory.
- Quotes both bid and ask prices continuously
- Provides liquidity so others can trade instantly
- Profits from the bid-ask spread
How Market Makers Work
Market makers bridge buyers and sellers:
Market Maker Activity:
Trader A wants to buy:
→ Market maker sells from inventory
→ Receives ask price (₹100)
Trader B wants to sell:
→ Market maker buys into inventory
→ Pays bid price (₹99)
Market Maker Profit:
Sold at ₹100, Bought at ₹99
Spread profit: ₹1 per share
Volume: 10,000 shares/day
Daily Profit: ₹10,000 (before costs/risk)
Quick Reference: Market Maker Role
| Function | What They Do | Benefit to Market |
|---|---|---|
| Provide Liquidity | Always ready to trade | Instant execution |
| Quote Prices | Bid and ask prices | Price discovery |
| Absorb Imbalances | Buy when others sell | Smooth price movement |
| Narrow Spreads | Compete for flow | Lower trading costs |
Example: Market Making in Action
Order Book with Market Maker:
Without Market Maker:
Bid: ₹95 (single buyer)
Ask: ₹105 (single seller)
Spread: ₹10 (10%)
With Market Maker:
Bid: ₹99.50 (MM + others)
Ask: ₹100.00 (MM + others)
Spread: ₹0.50 (0.5%)
Result:
- Tighter spread = lower costs
- Immediate execution possible
- Fair price discovery
Market makers provide liquidity by quoting bid and ask prices continuously. They buy from sellers and sell to buyers, profiting from the spread. Without market makers, finding counterparties would be slow and expensive.
Market Maker Obligations
Continuous Quotes
Must maintain bid and ask prices during market hours.
Minimum Size
Must offer to trade minimum quantities at quoted prices.
Maximum Spread
In some markets, spreads can’t exceed certain limits.
Inventory Management
Must hold positions even when risky, then manage that risk.
Market Maker Risks
Inventory Risk
Holding stock that drops in value before selling it.
Adverse Selection
Informed traders trade against market makers who don’t know the news yet.
Volatility Spikes
Fast moves can cause large losses before quotes adjust.
Competition
Multiple market makers compete, compressing profits.
Market Making in India
ETF Market Makers
Designated market makers required for ETFs to maintain liquidity and NAV alignment.
F&O Liquidity
Options market making by proprietary desks and algorithmic traders.
Equity Markets
No formal designation, but prop desks and algorithms provide market-making function.
Retail Traders as Liquidity Providers
You can capture spread by using limit orders:
Current Market:
Bid: ₹99.50
Ask: ₹100.00
Your Limit Buy: ₹99.60
If filled, you bought below ask (saved ₹0.40)
Your Limit Sell: ₹99.90
If filled, you sold above bid (earned ₹0.40 extra)
This is “passive” trading—providing liquidity instead of taking it.
Common Mistakes
-
Viewing market makers as adversaries – They provide a valuable service. Use them.
-
Ignoring spread when trading – The spread is real cost. Factor it in.
-
Market orders in thin markets – When no market maker, you get terrible fills.
-
Trading against informed flow – Market makers lose to informed traders; so might you.
How JournalPlus Tracks Execution
JournalPlus logs whether you used market or limit orders, helping you analyze if passive (maker) orders improve your execution versus aggressive (taker) orders.
