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About Market Making

Who are market makers?

We are mathematicians, technologists, data scientists, operations experts and researchers who harness the latest trading technologies to serve a unique role in Europe’s financial markets. 

We are intermediaries who support investors by providing liquidity: enabling them to buy or sell at market prices when others may not be. We commit to being actively present in the financial markets at all times, ensuring investors can always make a transaction, as soon as they want to, at the best prices and with the lowest costs.

What we do is sometimes referred to as proprietary trading or “prop trading”. But whatever you call it, the outcome is the same: we offer investors absolute certainty that they will be able to make a transaction. This certainty helps to create confidence within the financial markets as a whole, making the markets more resilient, and enabling companies and societies to thrive.

How do market makers make money?

When an investor either sells to, or buys from, a market maker, it means the market maker takes a position; this immediately creates the risk that the price moves against them, which could result in a loss on the transaction. Market makers aim to manage this risk by trading very quickly on the opposite side, capturing what’s known as the “bid and ask spread” as their compensation, but mostly need to hedge their position to offset their risk with a different product.

Being quick enough to provide this service and, at the same time, benefit from the (albeit tiny) spread  is where market makers largely earn their keep. But it’s a narrow margin business, which means they need to be constantly on their toes, offering the right prices across many markets and products, and all at the same time. Market makers constantly invest in cutting-edge technology to stay competitive.

How do market makers help investors to manage their financial risk?

Because market makers commit to being actively present in the markets at all times, investors don’t have to risk waiting…and waiting…and waiting to make a transaction. They know they can always trade and receive the best price available, even in volatile markets. This certainty creates confidence within markets which, in turn, encourages ongoing investing – a virtuous cycle known as “liquidity.”

By always posting the best bid and ask prices, they help to keep prices stable. Without market makers, markets would be much more likely to spike and dip unpredictably, creating a really challenging environment for investors in terms of their financial risk management.

Is market making a form of algorithmic trading or automated trading?

In today’s highly competitive electronic markets, market making is a form of algorithmic trading (also referred to as “algo trading”), that takes place at a rate of action of which only computers are capable. Mathematicians, computer scientists, data scientists, operations experts and researchers design the cutting edge trading strategies that technology then executes; with computers continuously providing competitive quotes in multiple products on multiple exchanges.

To achieve this, market makers connect many computers running trading software to the exchange. They analyse huge amounts of data to quote the best prices, while at the same time effectively managing their associated risks. Although the orders are executed electronically,  they are controlled by both a risk manager and commands within the software.

What do market makers buy and sell?

Market makers are active in all asset classes by buying and selling equities, bonds, interest rates, commodities, currencies and Exchange Traded Funds as well as derivatives such as futures and options. These are all also known as “financial instruments” and as a group are often referred to as “securities”.

How do people pursue a career in market making?

Fundamentally, market making firms are looking for bright minds, but it usually helps to have a university education in a relevant subject such as maths, physics, statistics, computer science or engineering. 

Many market making firms offer internships for those straight out of university. But seeking out any kind of relevant, entry level experience, such as an internship in trading, asset management or something else related to financial markets is a great way to gain working knowledge and show a passion for the sector. 

Working in an entry level role also offers the chance to test out whether you feel you have the right qualities to be a market maker. For example, you’ll need to be entrepreneurial, be capable of thinking quickly and be able to stay calm under pressure.

Which firms specialise in market making?

Principal trading firms, also known as proprietary trading or prop trading firms specialise in market making. Also some Investment Banks operate as market makers. In general, the members of industry body, FIA EPTA,  are a good representation of Europe’s market making firms. You can find FIA EPTA’s member list here: https://www.fia.org/epta/fia-epta-membership

What role do market makers have in sustainable finance?

Market makers are committed to facilitating climate action under the European Green Deal. Firstly, they support exchanges and issuers to design and launch new sustainable investment products. Then they provide valuable liquidity in these innovative green finance products to help to foster their growth. This actively enables the development of sustainable investing, supporting the green transition and post-Covid recovery.

Terminology

What is liquidity?

Liquidity refers to the ease with which a financial asset (for example a stock or share, bond or derivative) can be bought or sold on the financial markets at a price that reflects its current value. Market makers are valuable liquidity providers because they commit to being actively present in the markets at all times, which means investors can feel confident that they can always trade and receive a reliable price, even in volatile markets. This investor certainty creates confidence within markets as a whole which, in turn, encourages ongoing investing: this is the virtuous cycle of “liquidity.”

What is a liquidity provider?

A liquidity provider is a broader term describing what market makers, in particular, do. They commit to being actively present in the markets at all times so that investors know they can always buy or sell as soon as they want to, and will always receive a reliable price, even in volatile markets. This certainty creates confidence within markets which, in turn, encourages ongoing investing – a virtuous cycle known as “liquidity.”

Any participant in the financial markets that contributes to liquidity can be classed as a liquidity provider because every trade consists of two participants: the buyer and the seller, and both provide liquidity to one another. But not all types of liquidity provider have a formal designation, whereas market makers are a regulated category of liquidity provider that comes with specific obligations, including the obligation to quote continuously and be ever-present in the markets.

What is the bid and ask spread?

On any exchange-traded market, the “bid” is the highest public price a buyer is willing to pay, and the “ask” or “offer” price is the lowest public price at which a seller is willing to sell, at any given point in time. The difference between the bid and ask price is called the “bid and ask spread” or simply “bid ask spread”.” 

 When a market maker buys or sells, they can very quickly trade on the opposite side. For example, if they buy a stock or bond, they can almost immediately sell it again if someone else is trying to buy. This helps them to manage the risk that the price of that stock or bond could move against them. When they quickly trade again, they hope to capture the “bid and ask spread” as their compensation. In this example, to sell that stock or bond for slightly more than they bought it for. It is most likely that they’ll need to hedge their position to offset their risk with a different product.

What is the difference between algorithmic trading and automated trading?
Algorithmic trading, sometimes referred to as “algo trading”, uses an algorithm to calculate the price, timing, quantity and other characteristics of orders (requests to buy or sell), which manual traders can authorise in part or in groups of orders. Algorithmic trading is not per se automated as the actual control of sending of orders can still be done manually. Algorithms on itself may change frequently hence the human importance to keep optimizing the algorithm.

Automated trading is where computer software is used to fully automate order generation. Computers are linked to market data, which is fed into algorithms, and then automatically place orders in the market. Although the systems trade by themselves, they are controlled by both a risk manager and commands within the automated trading software.

What is market volatility?

Market volatility is when the financial markets experience periods of unpredictable price movements upwards or downwards. Market volatility can be caused by political and economic factors. A moment of political unrest in a country, for example, might provoke a negative reaction in investors. Likewise, sector and industry factors can cause volatility. For example, an adverse weather event in an area that produces oil might cause oil prices to increase suddenly, and this can have knock-on effects across the market for other sectors too.

Because market makers are always ready to trade and with the best price, market makers help to guard against market volatility and liquidity risk, creating more resilient financial markets for everyone.

What are capital markets?

Capital markets describe any exchange marketplace where financial securities and assets are bought and sold. They may include trading in stocks, bonds, commodities and derivatives on these asset classes. Examples of capital markets in Europe include Nasdaq, The Intercontinental Exchange, The Chicago Mercantile Exchange, the London Stock Exchange, Euronext, Deutsche Boerse, CBOE and many others. All these markets provide public prices any investor can see and interact with. Market makers are fundamental to the fabric of capital markets because they are always ready to buy and sell, as soon as investors want to, and at the best prices. Their contribution helps to create resilient capital markets that enable companies and societies to thrive.

What is buy-side?

Buy side is a term used in relation to financial trading and, as the name suggests, it refers to organisations that sit on the “buying” side of the transaction. Their counterpoints are known as the “sell side”. The types of organisations that can sit on the “buy side” of transactions include asset managers, mutual funds, pension funds, insurance firms, hedge funds, private equity investors, retail investors.

What is sell side?

“Sell side” is a term used in relation to financial trading and, as the name suggests, it refers to organisations that sit on the “selling” side of the transaction. Their counterpoints are known as the “buy side”. Proprietary traders and market makers (including investment bank prop desks) are known as the “sell side”.

About #WeAreMarketMakers

What is the #WeAreMarketMakers campaign?

#WeAreMarketMakers is a campaign to promote better understanding of modern market making, what it does and its benefits for the wider world. It is being run by FIA EPTA, the industry body for proprietary trading and market making companies, as part of its 10th Anniversary activities, and is supported by FIA EPTA’s 30 member firms, as well as the exchanges with whom they conduct their business.

The campaign aims to help inform and educate people on the important role that market makers play: from providing liquidity to the global financial markets to supporting citizens’ pension pots.It also hopes to debunk some of the myths surrounding the industry around algorithms, and put forward the people and innovators behind the industry. 

What is FIA EPTA?

The FIA European Principal Traders Association (FIA EPTA) represents Europe’s leading Principal Trading Firms. Its 30 members are independent market makers and providers of liquidity and risk transfer for end-investors across Europe. It works constructively with policymakers, regulators and other market stakeholders to ensure efficient, resilient, high-quality financial markets. To find out more visit https://www.fia.org/fia-european-principal-traders-association