Market making, as the name suggests, is simply the science of creating markets in situations where the same is somehow difficult to find. That might sound somewhat ambiguous, but here is a simple illustration to further expound on the said term.
Think of a scenario in which you are trading a certain specified financial commodity and at the same time you are unable to find the ideal potential buyer. In such a situation, you might be forced to find a specialized person to find a market for that financial commodity subject to the said inability to find one on your own.
If successful, such an undertaking will enable you to find a market for your financial commodity enabling you to finally make a sale. As such, market making is simply a process characterized by the involvement of market experts or specialist intermediaries who aid sellers of financial commodities to find potential buyers creating a market for such commodities.
What is a Market Maker?
As discussed herein above, market making involves intermediary specialists and market experts. These individuals and agencies, as might be the case, who facilitate that linkage between willing sellers and potential buyers are the ones referred to as market makers.
What Do Market Makers Do?
The inability to find potential buyers ready to buy financial commodities or the inability to find willing sellers in the event buyers place orders in regards to said commodities disrupts smooth flow of the market. By facilitating timely linkages between willing sellers and potential buyers, market makers restore that smooth market flow, consequently ensuring high market volatility.
How Does Market Making Work?
To begin with, it is vital to understand that market makers have no inherent interests whatsoever in regards to the commodities that pass through them. This doesn’t mean that they do not benefit from the market making process in any way otherwise nobody will get involved in such activities. These intermediaries basically buy commodities from willing sellers and sell them to potential and interested buyers at a markup price.
For instance, a market maker will buy a financial commodity at $200 and offer to sell it at $205. Similarly, a market maker will take up an offer to buy financial commodities at $205 from a potential buyer and offer to buy the same from a willing seller at $200.
From the above illustrations, you will realize that there is a $5 dollar difference between the bid price and the ask price. Market makers benefit from that difference, which is commonly referred to as “spread”. Considering that market makers services are mostly needed in presumably difficult market times combined with the understanding that financial markets are characterized by unforeseeable instabilities, market makers usually get to determine the ask as well as bid prices in order to cushion themselves from risks that might result to quite devastating losses. They can also adjust their offers to match the prevailing market conditions which again helps them mitigate the risks of accruing losses.
What Are the Benefits of Market Making?
In addition to lightening the buy and sell processes, market making enhances financial commodities liquidity maximizing returns to subject investors. They also mitigate the risks associated with market slowdowns, which can be quite devastating and more so for startup companies.