What do market makers do?
We probably all take for granted our ability to buy or sell a stock at a moment’s notice, but have you ever wondered how this is possible? Whenever an investment is bought or sold, there must be someone on the other end of the transaction. It is very unlikely you are always going to find someone who is interested in buying or selling the exact number of shares of the same company at the exact same time. This begs the question, how is it that you can buy or sell anytime? This is where a market maker comes in.
A market maker is a company that stands ready every second of the trading day with a firm ask and bid price. When you place a market order to sell a hundred shares of Ahold, the market maker will actually purchase the stock from you, even if he does not have a seller lined up. In doing so, they are literally “making a market” for the stock. Without market makers, it would take longer for buyers and sellers to be matched up with one another, reducing liquidity and potentially increasing trading costs.
You might wonder how market makers make their money. Using our previous example, the market maker may purchase your shares of Ahold from you for $100 each (the ask price) and then offer to sell them to a buyer at $100.05 (the bid price). The difference between the ask and bid price is only $0.05, but by trading millions of shares a day, he has managed to pocket a significant chunk of change to offset his risk.