We’ve all found ourselves in a position where we have to buy stocks fast or get rid of them even faster. However, there were plenty of times when we simply have not been able to find an interested party. With no buyers or sellers, we were left at a loss. Furthermore, if we had to sell quickly, but were unable to do so, we would lose a lot of money.
Luckily for all of us, there is a solution and we can find it in the hands of a market maker.
What Does A Market Maker Do?
A market maker is an individual or a company that is always ready to sell or buy any kind of goods or financial instruments. Hence, we can also call the market maker a liquidity producer.
In short, a market maker will always buy the stocks we need them to buy, or sell the stocks we want them to buy even if there is no demand for such actions. This is why we call them market makers — they literally create a market.
Let’s say that, for some reason, we need to sell 500 shares right away but there is no demand for what we wish to sell. In that case, a market maker is called upon to buy our stocks at a lower price. We get the money we needed fast, and the market maker can resell those stocks at a higher rate, thus making a profit.
On the other hand, if we need to buy 500 shares immediately and no one is willing to sell, we are also going to call a market maker. However, since they also need to make a profit, we will buy the stocks at a higher than the market price.
Basically, a market maker reduces the time necessary for a buyer and seller to meet each other. Otherwise, the liquidity of both would suffer.
But why does a market maker sell above market rate, and buy under the market rate?
A market maker takes very high risks with each transaction. There is a chance that the shares they bought from us will lose value, making big losses for them. This is why a market maker needs to maintain a big spread on each stock.
If they buy 100 stocks from us for 10$ each, they will try to sell them at 10.05$. This may not seem like a lot, but we do need to remember that a successful market maker handles millions of shares a day.
On the other hand, if they buys 100 stocks for the same price, there is always a risk of their value plummeting afterward. This will create losses for the market maker. Because of that, he needs to insulate himself with lower than market buying prices.
Advantages For Investors
Just because we are using the services of a market maker doesn’t mean we will automatically be at a loss. There are three main advantages we can use:
- Any price is better than no price. Market makers allow us to liquidate our assets at any time thus avoiding losses.
- There is a huge competition between market makers. Consequently, we will receive better prices.
- We can use the market makers as a source of information on a given company. There are good reasons why no one wants to buy or sell certain stocks.
We may not always be able to find a buyer or a seller when we need one. Instead of losing money, we can find a market maker for all our urgent liquidation needs. The only thing to keep in mind is that we need to choose our market maker carefully.