What is Market Maker, Market Taker?
Market makers and market takers are terms used to describe the two main types of participants in a financial market.
A market maker is a participant in the market who buys and sells securities for their own account and is willing to provide liquidity to the market by continuously quoting both buy and sell prices. Market makers act as intermediaries between buyers and sellers, and they profit by taking a bid-ask spread, which is the difference between the price they are willing to pay for a security and the price they are willing to sell it for.
A market taker, on the other hand, is a participant in the market who buys or sells securities by taking the best available price from a market maker or other market taker. Market takers do not provide liquidity to the market, as they are only interested in executing their own trades at the best possible price.
Market makers and market takers play important roles in the functioning of financial markets. Market makers help ensure that there is always a buyer and seller available to trade a particular security, while market takers help increase market liquidity by providing an outlet for market makers to sell the securities they hold.
It's important to note that both market makers and market takers are subject to regulations that are designed to ensure fair and transparent markets. For example, market makers may be required to maintain minimum levels of capital, and they may be subject to restrictions on the size of their positions or the spread they can charge. Market takers, on the other hand, may be subject to restrictions on the size of their trades or the frequency with which they can trade.
Simplified Example
Market makers and market takers are like two different kinds of shoppers at a store. A market maker is like a shopper who always wants to buy and sell toys, even when no one else is buying or selling them. They help make sure the store always has a good selection of toys, and that prices are stable.
A market taker is like a shopper who only buys toys when they can find a good deal and sells when they think they can make some money. They don't help the store keep a good selection of toys, but they do help the store figure out what toys are popular and what the prices should be.
Just like in the store, in a financial market, market makers help make sure there is always trading happening, and market takers help figure out what prices should be for different assets.
History of the Term Market Makers and Market Takers
The concepts of market makers and market takers have roots dating back to the early days of financial markets, evolving over time to define the roles of participants within trading ecosystems. The term "market maker" traces its origins to the emergence of organized financial markets where individuals or firms took on the responsibility of ensuring market liquidity. This role evolved as centralized exchanges developed, establishing the need for entities to continuously quote bid and ask prices, allowing for seamless trading. The concept gained prominence in the mid-20th century as financial markets grew in complexity and sophistication, becoming a fundamental element in stock exchanges, forex, and other trading arenas.
Examples
Market Maker: A market maker is a person or firm that provides liquidity to a financial market by making bid and ask prices for assets. They are willing to buy and sell assets at all times, even when there are no other buyers or sellers in the market, helping to ensure that prices remain stable and trading can continue smoothly. An example of a market maker is a large investment bank like Goldman Sachs or JPMorgan Chase.
Market Taker: A market taker is a person or firm that buys and sells assets in a financial market by taking the best available bid or ask price. They typically trade in large volumes and are not willing to provide liquidity to the market. An example of a market taker is a hedge fund that actively trades in and out of financial assets.
High-Frequency Trading (HFT) Firm: A high-frequency trading firm is a type of market participant that uses advanced technology and algorithms to trade financial assets at high speeds. HFT firms are often both market makers and market takers, as they can use their technology to provide liquidity to the market when necessary, but also trade as market takers when advantageous. An example of an HFT firm is Jump Trading LLC.