Market Maker - Overview
A market maker is a dealer that buys and sells securities for their clients, firms, or their own individual accounts. Market makers primarily operate on the Nasdaq Stock Exchange and provide the structure and order for trading. Market makers unlike specialists or floor traders can work remotely from offices. Market makers trade on an electronic system run by the National Association of Securities Dealers (NASD) and have done so since 1971, when the Nasdaq began operations. The market makers primary responsibility is to display quotations for buy and sell offers that can be guaranteed for a certain number of shares. If these prices are hit, the market maker stands ready to use its own inventory to maintain balance in the trading of the security. This process is all done electronically and within seconds. It is important for day traders to to be aware of the trading tactics and methods of market makers.
How do Market Makers make money?
Market makers make the majority of their money with the following methods: (1) capturing momentum moves, (2) commissions, and (3) bid/ask spread. When market makers see stocks making sharp moves, with high liquidity, they will jump on board of the breakout to scalp quick profits. Market makers also make commissions on large institutional orders. Unlike retail investors that may move 100 to 1,000 shares at a time, institutions will have 25,000 to 1 million share block orders. If the institution attempted to flood the market with this order, the huge imbalance of float will likely cause a spike in price movement. Therefore, marker makers will guarantee a price for this transaction and will take a commission from this trade. Lastly, market makers make money off the bid/ask spread on a security. Since the market makers are guaranteeing to use their own inventory to guarantee a publicized quote, the market maker will make the difference of the bid ask spread for taking on this risk. So, if a stock is bidding at $50.00 and asking at $50.10, then the market maker would stand to make $.10 for every share traded.
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How to become a Market Maker
Becoming a market maker requires an approved membership from the Nasdaq Stock Exchange. In order to maintain order and standards on the exchange, all potential market makers must complete the process and meet strict trading practices and standards.