Definition / Examples of Market Maker Spread
Market maker spread is the difference between the price at which a market maker offers to buy a security and the price at which they offer to sell it. Generally, a market maker will buy securities at less than the current quoted price and sell them at more than the current quoted price. The market maker can be either the buyer or the seller at any given time to create a market for securities, and the spread is part of their compensation for facilitating transactions.
How does Market Maker Spread Work?
Have you ever noticed that the final price of a stock you buy or sell is slightly different from the current stock price? This can be due to the market maker spread. Note: The current stock price may not be the same as what others want to buy or sell it for. Market makers, in particular, need to consider the risks of buying and selling stocks at any time.
Thus, the market maker spread or the bid-ask spread allows the market maker to buy securities for slightly less than the current quote and sell them for slightly more than the current quote to help them make a profit. In turn, investors benefit from the availability of buyers and sellers in the market.
Securities with high trading activity (i.e., they are liquid) typically have narrower spreads, while those that trade infrequently (i.e., they are illiquid) tend to have wider spreads. The narrower the spreads, the closer they are to the official market quote for the security.
If a stock is very popular and the current quote is $50, for example, you might be able to sell it for $49.99. But if there is very low trading activity for a more specialized stock, you may only be able to sell a stock quoted at $50 for $49.50. These market spreads help the market maker account for the risk of not being able to find another buyer for the illiquid stock for a period.
Market makers do not want stocks to move while they are not buying or selling to make conventional investments. They buy and sell to create a market, which is facilitated by the spread.
What Does Market Maker Spread Mean for Individual Investors?
Understanding market maker spread can help you get a better price when buying or selling securities. If you simply click the “Buy” or “Sell” button through your brokerage app, for example, you might end up paying a higher amount to buy a stock than you expected. Or you might sell at a lower price than you expected. Instead, look at what your broker is offering as the bid and ask price to see what you can currently buy or sell.
Note: If you are not satisfied with the bid or ask price, one option is to set a limit price, if your broker allows that option. Limit prices help avoid bid or ask prices you do not want to accept. If you see that the asking price for selling a stock is $19.95 but you know you do not want to sell for less than $20 per share, you can place a limit order. Then the transaction will only be completed if the price moves to $20. If the asking price remains below $20 for the duration you set for the limit, the transaction will not occur, and then you can decide whether to adjust the limit price or hold the stock.
You may also want to compare the bid and ask prices among different brokers. Some brokers may have policies or relationships that can help you access narrower market maker spreads. Buying or selling with a few cents spread may not seem significant at first glance, but the more shares you trade and the more significant your overall investments, the more important the market maker spreads become to your net return.
Conclusions
Main
Market maker spreads are the difference between the bid and ask price. Market maker spreads help compensate market makers for entering as buyers or sellers at any time and bearing risks. Paying attention to the bid and ask spread helps investors get better prices when buying or selling securities.
Source: https://www.thebalancemoney.com/what-is-the-market-maker-spread-5197239
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