Market Makers are the people who make sure NASDAQ is an active stock exchange. They enable orderly, efficient trading and are thus indispensable to the markets’ efficiency. These members of the National Association of Securities Dealers (NASD) are firms that buy and sell securities at prices they publicly display on the exchange, thus competing for customer order flow. Market Makers further improve efficiency by actively managing their inventory. Through their deep domain expertise, they offer real-time transaction services, enabling a faster-paced marketplace.
At its essence, a Market Maker is in competition to receive customer order flow. They accomplish this by continuously quoting a bid and an ask price for a certain number of shares. This practice encourages value-add-first investors to come looking for companies to trade and builds confidence in the market structure overall. Once an investor decides to place an order, the Market Maker is there to respond quickly. They’ll buy from their own stock. Otherwise, they’ll soon find themselves on the other side of the trade and frequently execute these types of transactions in just a few seconds.
That immediacy, i.e. the real-time nature of these transactions, is key. After the MM has an order filled, it is able to rapidly buy/sell based on its inventory. This rapid-response approach reduces lag time and inflationary pressure. It’s through this process that investors can be assured that their trades can be quickly executed, something extremely important in the high-speed world of trading today.
Market Makers are not just passive players, they dynamically hedge their risks and adjust their strategies to changes in market conditions. By constantly repricing their posted prices, they communicate their intent to purchase or sell a security at predetermined terms. This forward-looking dynamic pricing strategy brings order flow to their doorstep. It fosters the most competitive environment in making other active market players being able to react rapidly to price changes.
Contribution Market Makers are important because they help shorten the bid-ask spread. This spread is the difference between what buyers want to pay and what sellers want to sell at. A tighter spread positively impacts both traders and investors by reducing the cost of transaction and improving market efficiency overall. This little remembered fact about their role is an important part about how NASDAQ’s market honestly works. High-frequency trading and extreme volatility associated with high-frequency trading often is the case here.
Market Makers are really at the mercy of the NASD’s ironclad regulatory guidelines. Crucially, these regulations require firms to hold enough capital reserves to absorb potentially catastrophic losses. This then allows them to maintain their liquidity provision obligations, safeguard investors’ best interests, and maintain market quality.
The competitive environment among MM’s ensures better technology and practices when it comes to trading. As you can imagine, these firms strongly compete for order flow. To increase their cost-effective execution capabilities, they frequently build out superior trading technologies and algorithms. This race for technological advancement benefits all market participants, as improved systems can lead to faster trades and better pricing.