Market Makers Make the Market

There is a relatively unknown force that keeps many markets moving, stocks included.  The “market maker” is a pivotal position within most all investment avenues.  A market maker stands ready to buy and sell, possibly at the same time, whatever assets they deal with.  In the case of any specific stock, the market maker will buy at a specified price and sell at a price a little higher.  this spread is where the market maker earns their income.  The benefit to the market is that liquidity is provided.  There may be a small interval in time when there are buyers but no sellers for a stock.  The market maker acts as a buffer here by absorbing that desire to buy by being obliged to sell their own holdings.

Market makers for stocks are typically large banks and investment institutions and are specifically registered as market makers.  They are required to be both a buyer and seller.  This risk is what justifies their reward.  The concept of the market maker goes outside of stocks.  Most commodities are sold through market makers.  Gold and Silver are the two common cases that you may have encountered in your daily life.  If you have ever been to a coin or pawn shop to buy gold or silver, the dealer will generally buy at spot price (market pice) and sell at a small premium above spot.  This is a market making function.  While not as formal as the stock market example, a local market maker will quickly lose business if they are selective about when they buy and sell or if their spread is too high.  Their worth is directly proportional to the amount of liquidity that they provide to their market.

One last note.  With all other factors the same, an increase in liquidity of an asset will increase the value of that asset.  Liquidity is a component of many comprehensive pricing methods.  Think about the difference between a house in an easy to sell area vs a house that may stay listed for a year or more.

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