The NASDAQ exchange uses a computer network for its operations. Transactions are conducted through market makers connected to this network. Market makers on NASDAQ fulfill a function similar to specialists on the NYSE.
Each market maker is an agent for stocks from a number of different firms and is authorized to manage trading in those stocks.
Each market maker is an agent for stocks from a number of different firms and is authorized to manage trading in those stocks.
Market makers differ from specialists in two main respects:
- They are not exclusive dealers; there can be more than one market maker for a stock.
- They mediate between members of the public, and not only between professional brokers.
Market makers continuously publish two prices for every stock for which they are responsible:
- A bid price – the price at which the market maker is willing to buy stocks.
- An ask price – the price at which the market maker is willing to sell stocks.
The bid price is always less than the ask price. The market maker uses this disparity, which is called the spread, to make a profit in much the same way that foreign currency is sold. The market price represents the average of the prices for all of the transactions that have been conducted.
Seemingly, being a market maker is not difficult since they always buy at less than the market price and sell at a higher price. This is true in a stable market. However, if the market loses ground quickly, then market makers lose money because their inventory of stocks quickly loses its value.
The smaller and riskier a firm, then the greater its spread and the fewer market makers it has. On the other hand, a large and well-established company has a small spread and many market makers.
For example, the spread on Microsoft can be as little as $0.01, while the spread on small companies can be $1, $2, or even more. Since each security can have a number of market makers it is possible to shop around.
