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I am trying to understand the role of a market-maker. So, the best bid and offer depend on where orders are resting, and these orders are from retail investors or institutions or whoever. Why is it said you buy from the market-maker when you issue a market order? Are you not just buying shares from the guy who had the best offer?

I understand this would make the stock very illiquid seeing as most market participants are likely to only place orders in areas of structure like swing highs and lows and the spread would be all over the place, so do market makers themselves place orders on the bid and ask to keep the stock liquid?

If market-makers hold inventory in a stock, is this done as soon as the company floats? Do you sell all your outstanding shares to market-makers who then sell it on?

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The role of the market maker is to make sure there is a bid and ask on a particular stock. That's it. The market maker ensures that there is a price at which you can buy and a price at which you can sell immediately, but these are not necessarily the best prices. The majority of trades do not involve market makers and occur between two third parties.

Whoever said a market order trades with the market maker is thinking of the way stock markets were years ago, not the way they are now. Market orders are supposed to execute immediately and at one time trading with the market makers was the method for executing immediately. If you issue a market order today, it executes with the best available limit order(s) on the other wide of the trade. This may or may not involve a party that identifies as a market maker.

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  • Thank's for taking the time to read my post and reply, It's much appreciated. So is their Market makers active in every stock? Or do they only have interest in stocks that have or will have high trading volume due to the fact that they make money on the spread on transactions. Can they keep a wide spread on low volume, low liquidity stocks to make up for the lack of transactions? Thanks again, any advice is much appreciated.
    – Jim Mcp
    Oct 10, 2017 at 9:22
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    @JimMcp My impression (which may be flawed) is that you'd be more likely to see them on low-liquidity shares where their job is to provide a ready market for both buyers and sellers (and in the process generate a bid-ask spread), sometimes at the behest of the stock-market itself (see Designated Market Makers on this Wiki page).
    – TripeHound
    Oct 10, 2017 at 9:41
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    There are 1000s of registered market makers. Every stock that trades on a major exchange has a market maker, sometimes many more than one. The MM is required to trade a minimum number of shares at his posted prices. But as mentioned by farnsy, the MM isn't necessarily the NBBO best price (other traders have placed limit orders at a higher bid or lower ask). Regarding options, MMs have limits on the size (maximum width) of the spread that they quote.
    – Bob Baerker
    Feb 17, 2022 at 19:59
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To bring up a somewhat different point than farnsy did, other entities can also have a dual function as a market maker. Like High Frequency Trading firms (HFTs) who in their practice of arbitrage and making money off slight pricing differentials (including bid/ask differences) will fill orders to attempt to make a profit off the spread.

Their (referring to market makers) general purpose is as previously stated to ensure liquidity in markets, including if that means at less favorable prices to retail investors.

But generally market makers will be willing to buy/sell assets as long as they can make a profit/ collect money from the spread. As to if they hold stock in inventory, that would depend on the specific firm and how they handle operations.

I hope this helps.

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  • I don't believe that's true. "market maker" is a specific term that refers to a stock exchange member who's required to provide liquidity for a security. The purpose of HFT is not to "ensure liquidity", but to profit from arbitrage.
    – littleadv
    Feb 17, 2022 at 23:05
  • I believe you misunderstood the writing flow. The "as previously stated" was referring to what others had said concerning market makers and not referring to HFT firms. Also in general HFT as an abstraction is different from HFT in practice in which the practice is closely integrated with market making regardless. I had imagined that was self explanatory given the first paragraph made no reference to liquidity insurance, while other answers did. Apologies for any confusion. @littleadv
    – Dot_plot21
    Feb 18, 2022 at 4:34
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    The point is that market makers are required to trade in their stocks even if it may not be profitable to them. While many traders create market by playing on arbitrage, they're not required to do that with regards to specific stocks. "market maker" is a specific thing, not just a random trader who trades a lot.
    – littleadv
    Feb 18, 2022 at 4:36
  • Yes, thank you I am aware of that, and I don't believe that was remotely contested in any response I've given. I believe you are fundamentally misinterpreting my statements. By stating that market makers "ensure liquidity" I am speaking to their obligations and requirements. I was making the point that the line between market makers has also recently become blurred. Also HFT firms are not "random traders who trade a lot" and the literature suggests the transition towards MM. sciencedirect.com/science/article/abs/pii/S1386418113000281 informs-sim.org/wsc15papers/027.pdf
    – Dot_plot21
    Feb 18, 2022 at 4:45

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