Markedsmaking

Markedsmaking, or market making, is a financial service in which a firm commits to quoting bid and ask prices for a financial instrument on a continuous basis, thereby providing liquidity to the market. The market maker aims to enable trading by ensuring there is a ready buyer and seller, and to earn profits from the bid-ask spread and from managing inventory.

Mechanism and operation: A market maker maintains two-sided quotes for a given instrument, such as a stock, bond, currency pair, or derivative. The quotes indicate the prices at which the firm is willing to buy and sell, and these quotes are adjusted in response to price movements, order flow, and risk exposure. The firm may also provide depth by offering larger trade sizes at the quoted prices.

Benefits and risks: Market making can reduce transaction costs for other participants and improve price discovery and liquidity, especially in less liquid markets. The market maker earns primarily from the spread and from favorable inventory management. Risks include inventory risk from price movements, adverse selection, and competition that can compress spreads or reduce profitability during stressed markets.

Scope and regulation: Market making occurs across asset classes such as equities, fixed income, options, foreign exchange, and crypto assets. Participants include large banks, broker-dealers, electronic market makers, and liquidity providers. Regulations often require licensing or registration, capital and risk-management standards, and rules to ensure orderly trading and fair access. In many jurisdictions, market makers may be subject to specific obligations to provide liquidity during normal market conditions.