Market Maker

Key Highlights

• It is a financial intermediary or institution that provides liquidity to financial markets by continuously quoting both buy (bid) and sell (ask) prices for securities, derivatives, or other instruments.

• Purpose of a market maker includes liquidity provision, price stability, efficient trading and market confidence.

What is Market Maker?

A Market Maker is a financial intermediary or institution that provides liquidity to financial markets by continuously quoting both buy (bid) and sell (ask) prices for securities, derivatives, or other instruments. Market makers ensure smooth trading, reduce price volatility, and facilitate efficient price discovery in equities, fixed income, and derivatives markets.

Purpose of a Market Maker

• Liquidity Provision: Ensures that investors can buy or sell securities at any time without significant delays.

• Price Stability: Helps reduce wide price swings by maintaining a continuous presence in the market.

• Efficient Trading: Supports high-frequency trading and large-volume institutional transactions.

• Market Confidence: Enhances investor trust by providing reliable bid-ask spreads.

How Market Makers Operate?

• Quoting Prices: Continuously provide bid and ask prices for securities.

• Inventory Management: Maintain a portfolio of securities to facilitate trades.

• Profit from Spread: Earn a margin from the difference between the buying (bid) and selling (ask) prices.

• Hedging Risk: Use derivatives and other financial instruments to manage exposure from inventory holdings.

Key Participants

• Market Makers: Banks, brokerage firms, or specialized trading firms authorized by exchanges.

• Investors & Traders: Benefit from liquidity and tight spreads.

• Exchanges & Regulators: Set rules, monitor compliance, and ensure fair market operations.

Advantages

• Immediate Execution: Investors can trade securities quickly without waiting for a counterparty.

• Reduced Volatility: Continuous quoting prevents abrupt price swings.

• Transparent Pricing: Bid and ask spreads provide clear market signals for entry and exit.

• Support for Derivatives & Structured Products: Critical for smooth functioning of options, futures, and other derivative markets.

Risks & Considerations

• Market Maker Risk: In volatile markets, they may widen spreads, increasing transaction costs.

• Inventory Exposure: Market makers can face losses if prices move against their held positions.

• Regulatory Oversight: Strict compliance with exchange and SEBI rules is mandatory to prevent market manipulation.