# How a Market Maker Works

A friendly trading stall that shows how a market maker posts a bid and an ask, earns the spread and keeps its inventory risk in check

By Jondher Alvarez

Topic: Society & Business

[Open the interactive Jig](https://ask.jig.com/j/xgC6UnXL7IRL)

## Transcript

### 1. Meet the market maker

Behind this counter stands a market maker: a trader who is always ready to buy or sell the same share\. Shoppers who want to sell come from the left, and shoppers who want to buy come from the right\. Stay a while and you will see how the stall earns money, and the risk it has to manage\.

Drag empty space to look around the stall\.

### 2. Two prices, always

The board always shows two prices\. The bid, in green, is what the maker will pay to buy a share\. The ask, in red, is what the maker charges to sell one\. The ask is always a little higher than the bid\.

For US shares priced over $1, prices move in steps of one cent\.

### 3. A seller arrives

A seller wants their money right now, so they take the maker's bid of $10\.00\. The share goes onto the maker's shelf\. That stock the maker holds is called inventory\.

### 4. A buyer arrives

Next, a buyer pays the ask of $10\.02 and takes the share off the shelf\. The maker bought for $10\.00 and sold for $10\.02\. That gap between bid and ask is the spread, and it is how the maker gets paid\.

Each block stands for 100 shares, so 2 cents a share earns $2\.

### 5. Many small trades

One trade earns very little\. A market maker trades again and again, all day long, so the tiny spreads add up\. Watch the jar fill while buyers and sellers take turns\.

For busy, popular shares the spread is often just one cent\.

### 6. Inventory risk

Sometimes the sellers keep coming and the shelf fills up\. Holding lots of shares is risky: if the price slips, every share on the shelf is worth less\. Here a 5 cent drop on 300 shares costs $15, more than many trades earned\.

### 7. Lean the prices

To get back to safety, the maker lowers both prices a little\. The cheaper ask tempts buyers, and the lower bid puts sellers off\. The shelf empties and the risk dial swings back to the middle\.

Market makers aim to hold close to nothing, not to bet on prices going up or down\.

### 8. Calm days and stormy days

When the market is calm and busy, the maker can trade out of shares quickly, so it keeps the spread narrow\. When surprising news makes prices jumpy, holding shares is riskier, so the maker widens the spread\. Switch between the two and watch the board\.

In January 2021, one hectic share's average spread jumped to about seven times its usual size\.

### 9. Why it matters

Thanks to market makers, anyone can buy or sell at once instead of waiting for a matching stranger\. The spread is the small price of that convenience\. When many makers compete, spreads shrink and everyone pays less\.

Market makers can lose money too\. The spread pays them for taking that risk\.