Many of these firms are market makers. That’s a role that has existed in markets well into the 19th century. Market makers are contractually obliged to offer a price for any security on their books. That means if you want to sell, you always can no matter what is happening in the market (unless it’s suspended). Nowadays all market makers (that I know of) trade algorithmically and given that volumes and speeds at which modern markets operate, it’s pretty much the only way they could without having to charge considerably higher market maker fees, increasing costs for everybody.
Furthermore, if I want to sell a security and one of these companies puts in the best bid, then I just made more money than I otherwise would have if they weren’t there. Likewise if I was buying, they might offer me a lower price. Isn’t that a good thing? They are happy and the counterparty is happy.
Then there’s arbitrage. If I am trading on an exchange, but there’s a better price on another axchange one of these firms trades on, they might offer me a better price than I otherwise get. Effectively I d get a price on the other market, without having the costs of trading on it. Again, that’s better for me, where ‘me’ might be your savings account or pension fund manager, or a manufacturer or producer on a commodities market. So these firms reduce costs for other participants on the market.
Market Makers are basically the financial system's buffers: they exist to make sure that you can always buy or sell a given security/commodity. They are the people who make buying or selling something _immediately_ possible, rather than having to wait for someone who needs what you're selling (or is selling what you're buying) to come along.
This makes trades move quickly, which speeds up price discovery. This is good for market health.
Market makers make their money on the difference between the buy-sell spread. Of course, this is a bet: if the market moves against them, they can lose money on this. Often a market has one or more officially designated market makers who are paid to _always_ have a certain number of both buy and sell offers on the market to ensure that there is always liquidity. The payments help cover their risk
(These payments are often also materialized in the form of a "takers fee", i.e. a surcharge you pay whenever you place an order into the market which can be immediately filled)
TL;DR: They're a warehouse which will always buy and sell some product, except when talking futures we're talking wagons full of nickel 1 month from now and so the warehouse doesn't physically exist
They are 'market makers'. If you're a big {pension, real estate, rrsp}fund and want to make a trade, say a purchase, you need to call your trader directly. The trader will sell you some of their own (if they have it on their books), or will contact other people who they think may have extra supply on your behalf.
They are the 'grease of the economy'. In theory, it makes markets run smoother, which leads to greater efficiencies for everyone, and makes the world a better place.
The market makers do understand why they are trading and understand it has nothing to do with fundamental value. That may be your reason for trading. They are there to rapidly and correctly assess short term supply and demand so they can extract compensation for providing liquidity. And that’s a good thing. A market made of heterogenous actors with different objectives and time scales is far more robust.
Yes they provide liquidity. But that is not the reason traders become market makers.
The liquidity is something that the exchanges want so they can provide better services to their other users / customers.
What the market makers get in return is some privileges on the exchange, such as favorable credit exempts or short sale treatments. This depends on the exchange.
But being a marketmaker, basically obliging to be able to quote a price on anything and everything, is regarded as much as a nuisance as it is a benefit.
They theoretically facilitate capital allocation by increasing liquidity and hence aid in price discovery, if they operate strictly within the market maker role. Whether it plays out like this in practice has been debated elsewhere.
My guess is that it helped financial derivatives take off. I've read about people trading puts and calls on tulips -- and then when that got boring, trading the same instruments on commodities and stocks at more legitimate exchanges.
This article is entirely devoid of content. It is completely worthless.
Newsflash for everyone thinking about being involved with the markets: the reason they work is because there are participants with different motiviations and ideas on how to make money. Period. By definition, the "plankton" of the markets are the market makers (both designated and implied, read passive HFT). These guys provide immediacy. They do that with the express intent of continuously trying to manage their inventory of any particular stock to 0 (with constraints of their pricing model). This directly implies they have a very high turnover and a holding period that is minimized as much as possible.
Why do they do this? Market makers provide a valuable service: immediacy. They supply to other traders an OPTION to trade with them by displaying liquidity on the standing limit order book. Therefore, they must deal with adverse selection (trading with counterparties who are more informed than they are). A market maker is there, ready to trade, and when someone lifts their offer or hits their bid they want to turn around and lay that position off as quickly as possible, ideally via another limit order being matched with a market order. This is the way they earn their living: by making the spread.
Market makers are not charities, they're there to provide a baseline for markets that don't have that many orders available (liquidity). This liquidity allows people to enter and exit positions more readily, encouraging real entrants to start trading the once quiet market.
People are more likely to trade if they feel a lower risk of being stuck in a 'bad' position.
Many times, exchanges actually pay market makers to provide liquidity to try and kickstart a particular market.
There is another kind of market maker whose job is to provide liquidity by always staying in the market. The exchange pays them some fraction of a penny per share bought and sold.
Would you mind explaining what prop trading is? I am not familiar with this term.
From what I know of market making however is that you match a buyer and a seller of an asset, correct?
If I do have this correct about market making. Are they playing ask buy spread? Whose best interests is the market maker supposed to look out for? The buyers? The seller? Some combination therein?
Could you explain this more? I don't know much about this world. I understand they are not making the world a better place, but are they making it worse?
Something that I have heard is that they are providing a service by providing liquidity to the market.
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