'Faceless' traders who make markets
FROM the small investors' perspective, a market maker is a seemingly faceless but fraught individual who buys and sells shares on the request of their broker.
But although market makers may not be readily visible to the man in the street, their role is evident in every transaction.
Simply defined as traders operating on a short-term view, market makers actually buy and sell the shares for clients, and it is for this reason the small investor may want to lend an ear.
A private individual is unlikely to buy a share directly from a market maker. The usual course is to use a broker, who will be remunerated for his or her services through commissions.
These services, among other things, include implementing the transaction and often offering advice on the shares.
While the broker will turn to the analyst for the information on which shares to buy, the broker's point of contact for transacting the deal is the market maker.
The two can either work in the same institution, such as that of a securities house, or separately.
The market maker covers costs through a ''bid-offer spread''.
This is a two-way price where the market makers buys at one price and sells at another, hopefully buying lower than the price at which the share is sold. The difference is what the market maker keeps.
If a share, for example, was buying at $3.50 and selling at $3.55, the bid-offer spread would be five cents.
The market maker can ask for such spreads because once he or she agrees to take on the client's share, he or she has to carry the shares until a buyer is found.
Large transactions, therefore, can mean the market maker is carrying large liabilities on the books.
The spread serves as a sort of cushion for the market maker. The size of the spread varies from company to company depending on the size of the cushion needed.
The more volatile the market, the bigger the cushion. The share prices of big companies, for example, usually have a smaller spread than those of small companies, which tend to be less liquid and thus more easily swayed by share deals.
Were the market to suddenly plunge after the shares were taken on, the market maker could potentially carry a big loss.
So where the likelihood of such an occurrence is greater, so is the spread.