- By Harsh Jain
Who are market makers:
A market maker is a participant in the financial market that engages in the buying and selling of significant quantities of a specific asset. The primary purpose of a market maker is to enhance market liquidity and ensure the efficient operation of the financial markets. While individuals can take on this role, it is more common for large institutions to act as market makers due to the substantial amounts of assets involved. Market makers maintain a certain inventory of the assets (or assets) they specialize in. They achieve this by promptly presenting buying and selling price quotes and executing trades at those prices. This approach simplifies the process of executing trades for other market participants.
Role of a Market Maker in IPO:
Market makers, as registered participants of the stock exchange, serve as stockbrokers responsible for consistently buying or selling securities in the stock market according to predetermined prices. They play a pivotal role in enhancing liquidity and enhancing the accurate determination of stock prices for listed companies.
Role of Market Maker in Crypto:
Market makers, whether entities or individuals, enhance market liquidity by engaging in the purchase and sale of cryptocurrencies with global traders, investors, and participants. They acquire cryptocurrencies from sellers wishing to divest and supply them to buyers seeking to obtain these digital assets.
Top market makers:
1)Flow traders:
Based in Amsterdam, this prominent proprietary trading firm, with global offices, employs high-frequency and quantitative trading tactics to furnish market liquidity. Commencing in 2004 with ETPs, it has since broadened to include fixed income, FX, commodities, and cryptocurrencies
2)Citadel Securities:
Established in 2002, Citadel Securities, a major market-making entity, operates globally with Miami, US as its base. With a presence in over 50 nations, it's a key player on the NYSE, offering primary liquidity for numerous renowned global companies. The firm participates in 100+ trading venues and trades across the top 15 equity exchanges, encompassing 88% of the global market capitalization.
3)DRW:
Founded in 1992 by Don Wilson, an options trader at the Chicago Mercantile Exchange, this Chicago-based firm now handles around 1 million trades daily, spanning traditional markets to emerging ones like cryptocurrencies. With over 1600 employees, DRW provides liquidity in ETFs, fixed income, commodities, currencies, and crypto markets, boasting capabilities for 1,000 trades per second.
Profit Making and Spread:
Market makers assume the risk of holding assets, as the value of securities can change between the time, they purchase them from sellers and when they sell them to buyers. To compensate for this risk, they earn a profit known as the market maker spread. This spread is the difference between the bid price (the price at which they're willing to buy) and the asking price (the price at which they're willing to sell). This spread accounts for their profit, covering the risk they take on.
Is the majority of market making computer driven?
While the exact percentage may differ depending on the source, algorithmic high-frequency trading (HFT) constitutes roughly 50% to 75% of trading activity in the U.S.
This technology introduces unparalleled speed and efficiency to market making, yet it has also led to contentious practices sparking suspicion around those employing HFT, whether individuals or institutions.
Two prominent market manipulation techniques are spoofing and front-running:
Spoofing: Spoofing involves placing a substantial order to buy or sell a security, intending to cancel it before execution. This tactic artificially influences prices, creating a deceptive appearance of heightened demand or supply.
Front-running: Front-running entails purchasing or selling a security while being aware of an impending large order execution. This provides the front-runner an unjust edge over other market participants.
Significance of Market makers’ impact on Markets:
Market makers have a significant impact on the market's overall health and stability. Without them, securities could become illiquid, making it challenging for traders to find buyers or sellers. The most effective way to comprehend this concept is by comparing a market with ample liquidity to one lacking it.
Imagine you're looking to convert your holdings in a tech stock into cash. In a market without market makers, you'd have to patiently wait for someone to place an order matching your selling price and quantity, hoping for a swift transaction.
Market makers, however, actively monitor the entirety of the market, spanning various assets like stocks, options, and futures related to stock indexes, often traded on multiple exchanges.
As a result, the bid-ask spread – the price difference between buying and selling – remains minimal, sometimes just a few pennies.
This narrow spread signifies a well-functioning market, alongside significant trading volumes on both sides. This exemplifies market efficiency.
The bottom line:
Market makers have a crucial function in maintaining the fluidity and efficiency of financial markets. Their role involves being constantly prepared to purchase and sell assets on demand. These regulated entities function within a fiercely competitive environment, ultimately working together to provide investors with a seamlessly operational market that presents competitive pricing.
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