Make a Market
What it is:
Making a market is a process whereby a person or brokerage house that is always prepared to buy and sell securities in order to provide liquidity to the markets.
How it works (Example):
In order to make a market, a brokerage firm must be willing to hold a disproportionately large amount of a given security so that it can satisfy a high volume of market orders in a matter of seconds at competitive prices. If investors are selling, market makers are supposed to keep buying, and vice versa. They are supposed to take the opposite side of whatever trades are being conducted at any given point in time.
In this sense, market makers, as the name suggests, are able to satisfy the market demand for a security and facilitate its circulation. The Nasdaq, for example, relies on market makers within its network to ensure efficient trading.
It is important to note that market makers profit through the market maker spread, not by betting on the direction of the security's price. They are supposed to buy or sell securities according to what kind of trades are being placed, not according to whether they think prices will go up or down.
Why it Matters:
In contrast to conventional brokerage, making a market involves a high level of risk because of the high number of units market makers hold (their inventory). Market makers promote market efficiency by keeping markets liquid. To ensure impartiality for the benefit of their clients, brokerage houses that act as market makers are legally required to separate their market making activities from their brokerage sales operations.
