Unmasking the Market Maker

William Wells
Apr 25, 2018 · 5 min read

What is a Market Maker?

As if pulled straight out of a 1940’s comic book, the title “Market Maker” belongs up there with The Joker and Two-Face as super villains in Batman. In fact, many investors often regard the Market Maker (MM) as an evil figure manipulating stock prices and preventing anyone from gaining a profit but them self. However, when equipped with a detailed insight into a MM’s actual purpose, it becomes clear to see what a MM actually does and why their role is so crucial to the share trading world.

In its most simple form, a Market Maker is a hired financial company or individual that posses enough capital to buy and sell large amounts of stock as they become available. As traders, we often take it for granted how it’s possible that we can easily place buy/sell “market orders” and instantly receive either shares or fiat for the exact amount we agreed on. This is only made possible by the presence of Market Makers. Think of a MM as store where goods are traded and exchanged. The only way for you, the consumer, to purchase your desired goods, is to go to the store operated by the Market Maker. There is also the concept of a “Stockbroker”. Using the same analogy, the Stockbroker would be the individual that lead you to the Market Maker so you could purchase the goods from his or her store. In many cases, a computerized exchange will serve as a Stockbroker. Note: In traditional share trading, a broker is a person who receives buy/sell orders and “fills” them buy either filling the order himself, going to an exchange, or using a hired market maker.

Why are Market Makers Needed?

Market Makers are an important entity in the trading world. As we have already discussed, a Market Maker’s main purpose is to literally create a market. They create a market by always ensuring that there is someone willing to buy your sell order and sell you your buy order. This is best represented through an example: Say John wants to purchase 3000 tokens of Tron (TRX) for $.03ea, John is expecting his order to go through instantly. Another person, Sam, is selling 1000 tokens for $.03ea at the same time. John would receive 1000 tokens from Sam but where does the remaining 2000 tokens come from? Que Market Maker! The MM is obligated to fill the remaining order by selling the remaining 2000 tokens to John. There are a few additional items to note. The MM may have bought those 2000 tokens at $.05 thus incurring a loss. He/She does this because they are obligated as a Market Maker to fill any and all orders placed at a market price (unless the broker happened to fill it elsewhere). Many orders are sometimes completely filled by the Market Maker while others are completely filled without. The take away here is that even if the MM is not filling the order, they are on standby to do so should they be needed.

Put another way, Market Makers create liquidity in a given market. In investing, liquidity is a measurement on how easily a share or asset can be turned into something else — usually cash. Having MMs creating a market by being ready to fill orders, the liquidity of an investment increases dramatically. Liquid investments are ideal for investors.

The Actions of a Market Maker

Taking on the role as a Market Maker is risky. The risk stems from being duty bound to ensure orders are being filled. Just recently, a Tron MM unloaded billions of TRX tokens over the course of a few months taking the account almost to $0, only to replenish billions over a short 24 hour period. What could account for this behavior? When a Market Maker sees that there are a massive amount of buy orders being placed, they will start to meet those orders by selling. When the market starts to turn bearish, the MM will then switch to buying to fill the sell orders. Of course, the MM needs to monitor his or her own funds to make sure they continue to have the capital to fill orders. This may very well be why TRX saw the MM deplete funds only to refill quickly. Furthermore, a true Market Maker does not want to suppress or carry a market. This means that their purpose is not to manipulate markets and that their complex job is made even more complicated by having to fill orders, maintain a profit, and not manipulate the market.

Whales Vs Market Makers

Market Makers are not to be confused with Whales. Both are similar in the sense that they posses massive amounts of wealth but their goals are fundamentally different. Whales have one purpose, to make the most money they can. This is performed by making gains on the losses of others. They use tactics (not covered in this article) to start FOMO, FUD, or Panic Selling to make or manipulate the market to go in a direction in their favor. Interestingly enough, whales will often have their orders filled by MMs because their orders are so large only a Market Maker could fill it. It is also important to note that many individuals try to determine whether a trader is a MM or a Whale based on the size of their purse. This is not easily done. Only by a company announcing a Market Maker or by an experienced trader analyzing a series of trades can one deduce who is who.

History of Market Makers

Market Makers or “Jobbers” have had a long history dating back as far back as 1571; that clocks them in at a little over 400 years old! Original trades or stocks where loans scribbled on a piece of paper. Later investments included various commodities such as fruits and veggies or crafting material. Investments could even be full blown expeditions to foreign countries by boat in hope of finding gold! The issue presented with these dated investments was pairing a seller with a buyer. It could take days, weeks or even months to fill an investment request. Fortunately, market makers sped up this process tremendously. Even if they weren’t interested in fruits or crafting material — they would buy it and sell it a little higher thus, creating a market! Furthermore, if a jobber didn’t have the material on hand, they would take on the responsibility of finding a seller on behalf of the buyer — eventually they would make connections and the process would be easier.

By diving into this article, I hope that it becomes at least a little bit clearer on the purpose of a Market Maker. Their goals, dreams and ambitions aren’t so secretive or complex to understand that you need to view them as dark individuals. Good luck on your investments and feel free to comment for additional information.