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From what I understand from this MM vs specialist discussion ,

the job of the specialist is to bring buyers and sellers together as opposed to a market maker who buys from the seller and sells to the buyer, earning the bid-ask spread.

This seems to suggest that if I wish to trade on NYSE, I need not pay bid ask spread since there is no MM and I am directly dealing with the counterparty(buyer/seller). Is this right?

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All pay the bid/ask spread. It is a liquidation cost and very real.

There would not be a bid/ask spread if crossed, where a bid on one exchange is higher than the ask on another, or even locked, where the bid on one exchange is equal to the ask on another, markets were permitted by regulators. In such a situation, there would only be a trade cost, much smaller than the bid/ask cost but still not 0.

Just because a trader manages to sell at X+1 tick doesn't mean that they have bought at X-1 tick even though their bid if hit would allow them this profit. Both the higher ask and lower bid have to be hit simultaneously to guarantee a profit.

All participants are exposed to this risk. The risk can be reduced for liquidity providers by maintaining as little directional bias as possible; in other words, if the quantity short is equal to the quantity long then there is no directional risk.


EDIT

"Market makers", "specialists", "market making algorithmic traders", etc, etc are really all the same beast with a few tweaks here and there on rights and restrictions.

EVERY market participant no matter how enshrined with exchange rights is exposed.

Take for example a market maker of any variety, one who tries to profit by via the bid/ask spread. Imagine this market maker has posted the best bid and ask. Now, imagine the ask is hit, and one share of ABC is sold for X. This market maker is now exposed to any rise in the market. If ABC goes to infinity, the market maker is wiped out.

Or, there's the more realistic case where the market moves upwards, and now a bid at X-1 tick that ensures a profit by previously selling at X is now flooded with higher bids. What to do? Should this market maker dig deeper and post asks at the best ask? What if the market moves up again? Should this maker move up the bid guaranteeing a loss?

This mental loopty loop goes on every instant. It is a tough, tough business. It appears profitable because a liquidity taker is always paying the spread. Life is not as simple and easy for a market maker. Even if there is only one market maker on one security anywhere, they still have to play this game; otherwise, there is no market and a change would surely be made: either the market maker would go, or the equity would change exchanges, regulation notwithstanding.

It would be even harder for a market maker if locked and crossed markets were permitted, and one could make the reasonable assumption that it is their lobbyists mandating against those markets to protect their profits much like the current lunacy proposed for widening the minimum spread for small equities. Does that help you and me to pay an instant bid/ask cost? I think not. Does it help market makers to have wider spreads thus higher potential profit margins? Certainly.

  • Thanks. But bid-ask spread is the market maker's fee. But NYSE does not have MMs, it has specialists, so why one need to pay the bid-ask spread on NYSE? This is my confusion. – Victor123 Feb 12 '14 at 15:45

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