What Is a Market Maker?
Anyone who’s generally familiar with trading has heard about buyers, sellers, and brokers. But there is one type of market participants that often gets overlooked – market makers.
If you want to do well in this industry, you should learn who’s running the financial markets and who stands in your way. In this guide, we’ll be looking at market makers: everything from broad definition to common myths and trading advice.
Market Maker Definition
Market makers are also referred to as liquidity providers, which vaguely explains what they do. Market makers are usually large banks or financial institutions that keep the market functional by infusing liquidity.
In simple terms, they ensure financial assets could easily become “usable” money - if you want to sell an asset, they are there to buy it; if you’re going to buy, they can sell it. In turn, they profit from the bid-ask spread.
Market making is prevalent in currency exchange, where the participants tend to be banks and foreign exchange trading firms. In theory, an individual can also “make a market,” but the size of the investments needed is a big limitation. It takes enormous funds to be able to always stand at the ready to buy or sell.
Example of a Market Maker in Forex Market
Let’s say the current market price of EUR/USD is $1.05. Suddenly, there is news indicating that the EUR is going to rise. This should prompt individual traders to place market orders at $1.05. However, it’s safe to assume that there will be an influx of buy orders simultaneously.
A market maker, anticipating this behavior, sets the price at $1.10. Because of a high number of market orders, the market price can rise, let’s say, to $1.15, and because of the demand, fall back to $1.12. A market maker will then sell their EUR/USD inventory to meet peak demand at $1.15 and restock it when it drops to $1.12 for profit.
Types of Market Makers
Based on specialization, we can distinguish three types of market creators: retail, institutional, and wholesale.
This type arranges retail order flow and service customer orders coming from retail broker companies. In other words, they answer the needs of individual traders.
Institutional market makers operate with larger block orders. These can come from mutual funds, pension funds, insurance companies, and asset management companies. This requires them to help a substantial inventory on hand.
Wholesalers trade assets in large volume pools. Trading is often carried out through a high-frequency trading algorithm that optimizes the bundling and spread arbitrage strategy. These firms are responsible for order flow arrangements and compensate brokerages.
How Do Market Makers Work?
Market makers control how many asset units (stock, currency, etc.) are available for the market. Based on the current supply and demand of said asset, they adjust the price.
They provide liquidity for the order book by placing orders that can be matched in the future. Then, market takers (traders, for example) consume the inventory by taking the order from the order book.
Market makers are known to hold a disproportionately large number of an asset. The reason is they need to be ready for a high volume of orders in a short time at competitive pricing. If investors are buying, they are supposed to keep selling, and vice versa. Basically, they take the opposite side of trades that are being executed at any given point in time - i.e., act as a counterparty.
Each market has its own market creators. Meaning, each broker uses a quotation given by one or several market makers when offering prices to clients.
What Is the Role of a Market Maker?
To better understand what a market maker does, it is worth looking into the functions they perform in the market.
Price continuity characterizes a liquid market with a relatively small bid-ask spread. Essentially, it’s a cornerstone of reliable market making. A market maker should be able to show the ability and willingness to make a price in a range of sizes, even in spite of significant volatility. Capital commitment and diverse distribution channels play an important role in that.
It should be noted that market makers don’t provide price consistency for altruistic purposes. Even though it contributes to the market’s health, they have their own stakes. Market makers tend to incur losses at times when the price continuity rule isn’t fulfilled.
Market makers need to have a continuous presence and provide the immediacy of dealing. Whenever an asset is bought or sold, there must be someone on the other end of the transaction.
If an institution offers real-time trading to its clients, a reputable market maker will facilitate this functionality.
Flexibility and Coverage
Market makers enhance their service by providing flexibility in a number of areas. Particularly, they can offer non-standard settlement dates and the opportunity to settle in multiple currencies.
Moreover, instead of only picking a handful of assets, a market creator has to cover a broad range of instruments to its clients. This proves the market makers’ commitment to client satisfaction.
By intermediary function, we imply several ways of intervening in the market:
- Serving as a link between sellers and buyers.
- Determining the opening price. At the start of a trading session, a market maker must define the optimal opening price.
- Actively quoting two-sided markets. According to market rules, a transaction can only be made with the participation of a market maker. Meaning, online quotes provided by market makers can be considered legitimate.
- Providing up-to-date information to all market participants. For example, on market prices.
- Maintaining market balance. There are times when sell orders exceed buy orders significantly. In these cases, market makers use their own funds to ensure the balance of orders.
How Do Market Makers Make Money?
Market making is associated with risk brought over to trading books. To compensate for that risk, a market maker charges a fee in the form of commissions or the spread. Unlike traders, a market maker doesn’t raise money by buying low or selling high.
Let’s look closely at the two most important sources of market-making:
- Bid-Ask spread: Participants buy at market makers’ offer and sell to their bid. They keep the difference - the more transactions made, the bigger the profit. Spreads tend to be tighter in more actively traded names though, since there could be many market makers competing for a given asset.
- Commission: High volume clients such as brokerage houses are charged a fee. Usually, it doesn’t depend on performance and is charged for the services in general. Otherwise, it would create a conflict of interest between the client and the market makers.
How to Become a Market Maker
Anyone can become a market maker/liquidity provider if they meet the requirements. The catch is that it’s practically impossible for a regular person to perform the minimum trading functions. It’s more commonly a large institution that can sustain the required volume of trading.
But if you’re interested in the process of becoming a dedicated market maker, here is how it goes:
- Verify eligibility and become familiar with exchange expectations.
- Complete all necessary paperwork to get a market creator permit.
- File an application with authorized exchange staff.
- Provide proof for Guaranteed Minimum Fill for eligible orders.
- Wait for the solicitation and approval process.
If we look at the topic more loosely, we can even disregard the official “market maker” title. In essence, any participant with a significant share of operational volume “makes the market” in a way.
Advantages and Disadvantages of Market Making
The advantages of the market maker concept are especially interesting for smaller accounts and private investors. As for disadvantages, they are mostly applicable to advanced traders.
- Continuous trading throughout trading hours: A sufficient number of opportunities to enter and exit a trade.
- Competitive spreads guarantee: Spreads are kept fairly reasonable since there is stiff competition between numerous market makers.
- Investor confidence: Market makers have the expertise needed to analyze assets, and their activity can help indicate whether it’s worth investing in.
- Conflict of interest: Market makers are essentially traders’ counterparties. This creates a divide that investors need to be cautious about.
- Impact market integrity: Their actions affect the price in the market. This behavior comes with a risk of negatively affecting the health of the market and investing.
- Insider trading: Maker makers have information that isn’t disclosed to the general public that may lead to unfair profits.
Market Maker vs. Broker
Let’s avoid the confusion about market makers and brokers as they seem similar in many ways. The table below compares the two.
Act as a source of liquidity for exchange-traded assets
The main function is to facilitate the sale of an asset to a seller and the purchase for buyer
Large banks or financial institutions
Individuals or firms
Heavily influence the market
Don’t have a direct effect on the market
Profits from spreads between the price investors receive and the market prices
Profit from fees and commissions
Deep market insight (an advance look at all incoming orders)
Possess the same information as the rest of the market
Inherently risky business (occasional but severe market swings)
Not associated with many risks
Don’t work for clients; instead, they create a market for investors
Provide services for clients (consulting research, investing advice)
List of the Largest Market Makers
Below is the list of market makers that are considered the largest in the world. Bear in mind that it’s hard to compile the exact rating - but here are the companies that are worth traders’ attention.
GTS, a leading electronic market creator across global financial instruments - in total, over 10,000 different instruments globally. The list includes equities, ETF’s, commodities, futures, foreign exchange, and interest rate products. At the New York Stock Exchange alone, it accounts for $12.5 trillion of market capitalization.
This financial institution manages over $30 billion in assets and is responsible for over 28% of U.S. retail equity trading volume. In 2020, it was one of the few market makers that managed to increase its revenue despite the crisis. Due to an increase in volatility and retail trading, the company doubled its profit earning $4 billion.
J.P. Morgan is a global leader in financial services that aims to resolve the working capital and efficiency challenges. Technology powered by J.P. Morgan’s leading market-making franchise does the heavy lifting to aggregated liquidity. In 2019, the company was deemed “Best Market Maker (Major Currencies)” and “Best Market Maker in Emerging Markets” by Readers’ Choice Awards, Profit & Loss.
Deutsche Bank manages positions for its own account in the same products in addition to handling clients’ FX and PM products. This provides sufficient capacity to fulfill anticipated customer demand and react to market movements. Throughout 2020, the bank continued providing prices and make markets even on traditionally illiquid products (synthetic notes, long-dated cross-currency swaps, or structured products)
Jump Trading, the publicity-shy market creator using best-in-class technology and combines sophisticated quantitative research. Despite being in operation since 1999, the company remains highly secretive. Reportedly, Jump Trading and its sister company Jump Capital are currently diving deeper into crypto.
Myths About Market Makers
Most of us have heard the assumption that the market is manipulated by some power driving prices in whatever direction they need. If these beliefs are coming from newbies, it makes sense. However, blaming all losses on the puppeteers can quickly become detrimental.
Below are several myths that we can clarify.
They Have All the Power
If a market maker manipulated prices, they would be charged with a criminal offense. At the very least, they would be stripped of their license. This did happen in the past. For example, many Russian banks lost their licenses trying to manipulate the ruble exchange rate during the Russian-Ukrainian crisis.
Sure, markets can be manipulated. However, they are global in nature and have hidden political or economic motives rather than intervening into trading activity.
Market Makers Can Collude and Conspire
Once again, there are regulations in place that prohibit such activity. Collusions and conspirations with the aim of speculative profits aren’t tolerated. In fact, different liquidity providers are mostly in competing positions.
They Initiate the Majority of Trades
Market makers open approximately 10-15% of the total volume. Clearly, it’s not enough to fully form the market value of an asset.
They Arrange the Stop Loss Trap
There is a myth that a market maker can hunt stop losses. A market creator doesn’t target stop losses because they are insignificant for their activity and because they don’t see them until they become market orders. If they want to provoke the crowd to make trades in the right direction, they do it in other, more effective ways.
Why Should Traders and Investors Be Aware of Market Making?
Market makers have a significant impact on the market and hence, your trading success. Here is how you can use it to your advantage.
Include Market Makers into Fundamental Analysis
Don't get caught up with technical indicators - instead, make sure to include fundamental analysis in your trading strategy. Moreover, try to incorporate knowledge about market makers and how they keep the market balanced into your analysis.
If you’re trading in Forex, apply intermarket analysis with the stock and commodity market as they are closely related. It’s quite possible to find assets that are ahead of your selected currency pairs’ dynamics - this can be useful as additional indicators.
Trade with Market Makers, Not Against Them
You don’t necessarily need to overcome market makers, you can sometimes win by working just like them. Market-makers profit from impatient uninformed traders. Try to get in the mind of an informed trader and try to enter the market before the market maker balances it out. Analyze data on real volumes using exchange terminals or special indicators for MetaTrader.
Know How to Avoid Them
Finally, if you don’t want to deal with market makers’ direct influence, switch to a different time frame. Large players (except for HFT) aren’t interested in scalpers, and on medium-term trades, the risk of being affected by a market maker is much smaller.
It’s undeniable that the market maker’s role is technically difficult but has real value for the market and exchanges. These participants must commit to maintaining fair prices for different types of assets and to covering demand at any given time. Even if you didn’t know that before, market makers have always been present in financial markets. Otherwise, large-volume orders wouldn’t be executed with long delays and make trading impossible.
We highly recommend using any new information for the benefit of your trading activity. To get started on the right note, sign up for a demo account at Libertex. Here, you can practice and master your strategy risk-free.
When you graduate to a real account, you’ll be accustomed to how the market works and make informed decisions. And thanks to market makers and our top-of-the-line platform, you’ll be opening positions comfortably within a matter of seconds.
Why to trade with Libertex?
- access to a demo account free of charge
- technical assistance to the operator 5 days a week, 24 hours a day
- leverage up to 1:500 for professional clients
- operate on a platform for any device : Libertex and Metatrader 4 and 5
- no commissions for extractions in Latin America
Finally, we have prepared a quick round-up for this topic.
Who Are the Biggest Market Makers?
Aside from large banks or financial institutions that we mentioned in the article, we can also point out UBS, Citi, Barclays, Virtu Financial, Two Sigma Securities, Hudson River Trading, and AlphaTheta.
Is Market Making Illegal?
No, managing the spread and liquidity pool isn’t illegal in any market. As long as it keeps the secondary market as healthy as possible, it’s perfectly acceptable. However, there is a line where it could get illegal, such as wash trading and other efforts to push the price up.
Can Market Makers Lose Money?
Yes, market makers face the risk of being stuck in the wrong positions. For example, when they purchase from a seller and there is a sharp decline before it's sold to a buyer. Market makers are trading against market volatility and informed trade.
How Much Does a Market Maker Make?
It depends on different classes of market makers and where they are employed. According to Glassdoor, the average base pay is $98,000/year. But it can also go up to $150,000-$200,000/year.
Can Anyone Be a Market Maker?
Technically, yes. There is no rule stopping individuals from, and whenever you have a bid and offer entered, you are making a market, albeit a small one. But to actually influence the market, you’d need billions of dollars.
Do Market Makers Trade Against You?
Yes, but there is nothing to fear in the currency market. In fact, market makers sometimes have an incentive to lose. Their ultimate goal isn’t to profit off individual traders but ensure balanced market conditions for all.
Are Banks Market Makers?
Not all of them. On the one hand, banks do profit from making markets in conventional spot and forward foreign exchange contracts. Also, there is a degree of intermediation in volatility-related products. However, banks cannot accurately forecast changes in exchange rates, and there isn’t often enough earnings made from market-making compared to other sources.
Who Is the Market Maker in Forex?
Market makers create a digital market for the online trader. In Forex, market makers are funding banks, central banks, business banks, and massive brokerage companies.
What Is Market Making?
Market making is when a company or an individual buys and sells large amounts of a particular asset. Their main role is to ensure a certain level of liquidity and, thus, keep the financial markets running efficiently. These participants need to meet capital requirements in order to facilitate transactions.
What Is a Market Maker and Taker?
As the name suggests, market makers make the price and contribute a volume to the exchange’s order book. A market maker places the orders with prices that differ from the current market price. Market takers work with the price given to them and take volume off of the order book.
Can Market Makers See Your Stop Loss?
Stop loss orders are sent to the market, but they aren’t displayed on the public order book. Instead, it’s shown as any order to sell without clarifying it’s a stop loss. As for Trailing stops, your broker sits on it until triggered, and it’s only sent to the open market later.