When you consider the stock market, you will find investors who want to make profits and build wealth. The usual investors (like yourself) are called retail investors. There are other players in the stock market who are responsible for its smooth operation.
When discussing the stock market’s operation, we have to mention liquidity. Liquidity is a concept that ensures investors can buy and sell their shares easily. However, to ensure investors find buyers and sellers easily, the stock exchange employs market makers to infuse liquidity into the stock market.
This article will help you understand market maker meaning and how they help you in seamless investing.
Who are market makers?
Market maker’s meaning refers to member firms, companies, or financial institutions that a stock exchange such as NSE or BSE appoints to ensure there is enough liquidity in the stock market at all times. Liquidity refers to the concept that investors can easily find buyers or sellers of stocks without having to wait for a long time. The market makers are known to offer two-way quotes with both the buying and the selling price, allowing investors to know how much they will have to pay to buy a specific quantity of shares.
Market makers' main aim is to create market liquidity by increasing the trading volume. Market makers create bids where they showcase the quantity of stocks, their cost price, and the price at which they are willing to sell. It ensures that a buyer will get guaranteed shares at a set price. Although market makers can be individual traders, they are often associated in large numbers as they have to create and execute a large number of bids to reach their liquidity and trading volume goals.
Understanding market makers
The most common example of market makers are stockbroking houses that provide investing and trading services. Since these houses employ stock market experts, they are appointed by stock exchanges to ensure there is enough liquidity in the market. The stock exchanges fear that if a stock is highly illiquid, it won’t see volatility and will not change in price constantly. If a stock is not volatile at all, it will not see any demand from traders and investors, leaving the current shareholders without any sellers.
Market makers buy large quantities of targeted illiquid stock and hold the shares in their inventories. Afterwards, they create bids that mention the quantity, cost, and selling price. Once they receive buy orders from investors, they quickly sell the mentioned quantity of shares at the pre-mentioned selling price.
As market makers buy and sell equity shares in large quantities, the spread (difference between their buying price and selling price) is very low. For example, you may see a bid for 100 shares, where the buy price is Rs. 120.50 and the sell price is Rs 120.55. Here, the spread for the market maker is just Rs. 5, which is their profit for helping the stock exchanges create liquidity. The lower spread also benefits investors as they don’t have to pay substantially more for the stocks.
How market makers impact liquidity?
Market makers play an integral part in increasing the trading volume in the stock market. Without market makers, stocks will witness no liquidity, forcing them to see no price action. Since market makers provide two-way quotes (buy and sell price), they create utmost transparency and make the market a lot more secure and safer for investors. When you buy a bid created by a market maker, you know at what price the shares were bought by the institution and at what price they are selling the shares. There are no hidden costs, and you can buy the shares with a low spread.
Furthermore, the presence of market makers is also an analysis tool for investors and is included in the share market basics to grasp the current risk in a specific stock. If a stock is without any market maker, it may indicate that the stock is highly risky and can result in losses. Current shareholders can also adjust their positions based on market makers' entry and exit.
Factors to consider
Here are some factors that distinguish market makers as one of the most important players in the Indian stock market:
Bids
Every market maker creates a bid that details the number of shares, cost, and buy price. Any investor with a demat and trading account can enter a trade for the shares offered by market makers.
Directional-neutral
Market makers are considered directional-neutral. This means they do not have an opinion on the future price of the shares they are selling. Market makers try to profit from the spread and often mitigate risk by attaching their investments with correlated instruments such as futures or options.
Supervision
Although stock exchanges appoint market makers, the Securities and Exchange Board of India (SEBI) oversees their operations as it manages the Indian stock market.
Conclusion
The Indian stock market has different types of shares listed on the stock exchanges. However, the stock exchanges employ market makers to ensure there is enough liquidity and investors can easily buy and sell their shares. They buy the stocks, hold them in their inventory, and create bids for other investors. Once they get an order, they sell the held shares immediately and help increase the trading volumes. Now that you know the market maker meaning, you can make better-informed decisions by analysing their bids and buying shares easily.
