Risks of a Market Maker

In this article, we are going to talk about Market Makers again and some detail about the risks of a market maker which probably was not mentioned before.

Market Makers:

Market makers roles

As we had said before, every market-maker functions by displaying buy and sell quotations for a specific number of securities.

As soon as an order is received from a buyer, the Market Maker sells the shares from its inventory and completes the order. this process increases the liquidity in the market.

An important note is that Market demand dictates where market makers set their bid prices (what they’re willing to pay for shares) and ask prices (how much they’re demanding).  

The market maker could fail to find a willing buyer, and therefore, they would take a loss. That’s why market makers want compensation for creating markets. They earn their compensation by maintaining a spread on each stock they co

Generally,

Market Makers profit by charging higher ask prices than bid prices. The difference is called the ‘spread’. The spread compensates the market makers for the risk inherited in such trades which can be the price movement against the market makers’ trading position.

Risks of a Market Maker:

Dices cubes to the trader.

First, if you wish to know how much a market maker can make, According to Glassdoor it is roughly anything between $66,658 to $95,648 per year.

The primary risk a Market Maker can face is a decline in the value of a security . This decrease occurs after the value has purchased from a seller and before it’s sold to a buyer.

Market Makers are always counterparties to trades done by informed traders and in case of any volatility in the market; Market Makers will stick with wrong positions.

Another fatal risk for a Market Maker is not to have the latest information. In simple words, Market Makers can manage risks and survive only if they can receive & respond to information quickly. Or else, the market position can go against them even in a few seconds, and that can lead to losses.

Hence, strong markets must have strong Market Makers that survive without incurring huge losses.

overall

Market makers help financial markets by maintaining the efficiency of their operations. Market makers also help reduce price volatility which leads to fair pricing of the assets. It is important to note that low liquidity in the markets leads to the wide bid-ask spread. To get rid of the wideness in the bid-ask spread, market makers jump in and provide liquidity to the markets.