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My understanding is that a market maker profits by selling at or above ask and buying at bid or below in securities where there is a bid/ask spread and that's how they make money. If that's correct how do they even make money?

If a market maker is quoting a price to buy that is just below current bid will they ever get filled? Same if they quote slightly above the offer? Won't the order with a higher bid always get filled first leaving the market maker waiting?

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Market makers maintain continuous two sided quotes (bid and ask). Let's assume that the market maker is on both sides of the quote. If someone else trades at the market (buy at the ask and sell at the bid), the market maker earns the difference since he is selling at the ask and buying at the bid.

Any trader can offer a better price on the bid and/or the ask than the market maker. They then become the market and replace the market maker in the aforementioned pairing of trades. There have been times with illiquid stocks with a wide spread where I have been the best bid and the best ask, willing to unload at the higher price and willing to buy more at the lower prices. I temporarily became the market maker.

Traders and market maker will not be filled above the ask or below the bid (outside of NBBO) with single transactions. This does not apply to option spreads where the only requirement is to execute at the order's net price (the individual legs can be above or below NBBO).

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    So when a market maker quote on both side they take on a risk that they might not get filled on both sides right away, and might end up with a position on only one side at some point of time, is that right? – Vibhore Tanwer May 14 at 10:53
  • @VibhoreTanwer yes, this is one of the many risks that market makers take when they offer a two sided bid. – Philip May 14 at 11:31
  • Thanks @Philip. Makes sense. – Vibhore Tanwer May 14 at 11:51
  • Your comment implies that you think that the market maker gets stuck with long or short stock if only one side is filled. The market maker maintains an inventory of the stock. That's the risk they bear in return for the ability to capture the spread. – Bob Baerker May 14 at 13:07
  • Yes @BobBaerker That's news for me. I thought they would just quote on both sides using algorithms and get in and out quickly cashing out their profits, but if they keep an inventory then it must be a costly affair. My impression was they provide liquidity in market, is that done by keeping inventory? – Vibhore Tanwer May 15 at 10:14

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