Market maker
A market participant who continuously quotes both buy and sell prices for a security, providing liquidity so that other traders can deal without waiting for a matching counter order.
In plain language
An order book is not always full. For a thinly traded stock, a seller might wait hours for a buyer to show up at a fair price. A market maker fixes that.
A market maker is ready to buy or sell a security at any time, at prices it quotes itself. It earns from the small gap between its buy price and its sell price — the bid-ask spread — and takes on the risk of holding the security in between.
Because a market maker is always there with a two-sided quote, other traders can enter or exit a position quickly, even in a stock that would otherwise trade rarely.
How it works
The workbook (Chapter 2, Market Participants in the Securities Market) places market makers among the securities market intermediaries operating in the secondary market, alongside stock exchanges, clearing corporations, stock brokers, depository participants and institutional investors.
Exchanges run market making schemes for less liquid segments — commonly illiquid stocks, and instruments such as certain options series or ETFs — under which a registered market maker undertakes to provide two-way quotes of a minimum size, within a maximum spread, for a minimum proportion of the trading day. In return, exchanges typically offer the market maker fee waivers or other incentives.
A market maker's quotes sit in the order book like any other order and are matched on the exchange's usual price-time priority, so its presence does not bypass normal order matching; it simply ensures that a counter order is almost always available.
A worked example
ABC Ltd is a small-cap stock that trades only a few hundred shares most days. The exchange enrols a market maker, Vertex Securities, under its illiquid securities market making scheme.
Vertex is obliged to keep a live two-way quote of at least 500 shares on each side, with a maximum spread of less than 10% between its buy and sell price, for at least 75% of the trading session.
On a quiet Tuesday, Vertex quotes: buy 500 shares at Rs 118.00, sell 500 shares at Rs 120.00. An investor who wants to sell 300 shares immediately does not have to wait for another investor to place a matching buy order — Vertex's standing bid at Rs 118.00 absorbs the sale at once. Without Vertex's quotes, that investor might have waited days for a natural counterparty.
Why NISM asks about it
Chapter 2 (Market Participants in the Securities Market) lists the market maker among the participants who keep the secondary market functioning, distinct from stock brokers who act as agents for clients. Expect the market maker to appear as one option in a "who are the participants in the securities market" question, tested on its role of providing continuous two-way liquidity.
Common exam traps
- A market maker trades for its own account on both sides, unlike a broker, who executes client orders as an agent.
- It earns the bid-ask spread, not a brokerage commission.
- Its quotes still go through normal price-time priority matching — market making does not create a separate, privileged execution channel.
- Do not confuse a market maker with a specialist in the US sense holding an exclusive franchise on a stock; Indian market making schemes are typically open, incentive-based arrangements run by the exchange.
Check yourself
1.In respect of which of the following has market making been made mandatory for all scrips listed and traded?
- a)The SME Exchange
- b)The regular equity cash market
- c)The equity derivatives segment
- d)The currency derivatives segment
Show the answer
Answer: (a) The SME Exchange
In case of regular cash market and derivatives market liquidity scheme is mainly introduced by the Exchanges. However, for Small and Medium Enterprise (SME) Exchange, market making has been made mandatory in respect of all scrips listed and traded on SME Exchange. That is option A.
Options B and C are the markets where liquidity enhancement is mainly introduced by the Exchanges under SEBI's guidelines for Liquidity Enhancement Scheme in the Equity Cash and Equity Derivatives Segments — available, not mandatory. Option D has no market-making mandate in the workbook.
What a market maker does: the main responsibility of market maker is to provide two-way (buy as well as sell) quotes on a continuous basis with certain minimum amount and reasonable bid-ask spread. Market makers provide liquidity to facilitate efficiency in the functioning of the financial markets.
Where this is taught
Free preparation for NISM Series VIIRelated terms
- Trader WorkstationThe terminal through which a trading member logs in to the exchange's trading system to enter orders and view its own orders, trades and market information.
- Bid-ask spreadThe gap between the best buy (bid) price and the best sell (ask) price in the order book — the cost a trader bears for buying and immediately selling a small quantity.
- Liquidity Enhancement SchemeSEBI's market-making framework to make newly available commodity derivative contracts more liquid — dated July 2019 in one chapter of the workbook and 9 October 2018 in another.
- Long speculatorA trader who buys first and expects the price to rise — a long futures or option position taken with no corresponding short position in the spot market and no intention of using the commodity.