A market maker is a dealer that stands ready to buy and to sell the same asset, trading for its own account rather than for a client. US securities law puts it this way: a market maker is a dealer who "holds himself out (by entering quotations in an inter-dealer communications system or otherwise) as being willing to buy and sell such security for his own account on a regular or continuous basis" (Securities Exchange Act of 1934, Section 3(a)(38), 15 U.S.C. 78c). The price at which it will buy is the bid. The price at which it will sell is the ask. The gap between them is the spread. That spread is what a market maker hopes to earn, and it is also what the firm is paid for taking on risk.
How a quote works
A market maker posts a quote with two sides at once. If you sell, you hit its bid. If you buy, you lift its ask. Because the firm trades for its own account, it becomes the other side of your trade.
This is the difference between a dealer and a broker. A broker places an order for a customer. A dealer, and a market maker is one kind of dealer, takes the trade onto its own books.
The spread in one example
LuxAlgo, a vendor of trading tools, gives this hypothetical example in a post dated May 2, 2025: "Suppose a market maker buys 1,000 shares at $9.50 and later sells the same quantity at $9.60."
- Gross difference: 1,000 × ($9.60 − $9.50) = $100.
- As a share of the $9.55 midpoint, the $0.10 spread is about 1.05%.
- The $100 comes before fees and operating costs. It also comes before losses on any other position the firm holds, so it is not profit.
When the two prices are swapped, the same arithmetic gives −$100. That outcome is possible because prices can move before the firm unwinds.
Why the spread is not free money
LuxAlgo's own wording: "A quoted spread compensates for risks and operating costs; it is not a risk-free entitlement." Two risks matter most.
Inventory risk
Each fill leaves the firm holding something. Sell to a buyer and the firm is short. Buy from a seller and it is long. LuxAlgo defines the problem this way: "Inventory risk arises when a market maker accumulates a position whose value can move before it is offset." Thomas Ho and Hans Stoll's 1981 paper in the Journal of Financial Economics, "Optimal dealer pricing under transactions and return uncertainty," is one of the standard academic treatments of how a dealer sets prices under this kind of uncertainty.
Adverse selection
Some counterparties know more than the market maker. If the firm keeps selling just before prices rise, or buying just before they fall, those trades lose money on average. Lawrence Glosten and Paul Milgrom's 1985 paper, "Bid, Ask and Transaction Prices in a Specialist Market with Heterogeneously Informed Traders" (Journal of Financial Economics, vol. 14, pp. 71–100), shows that better-informed traders alone produce a positive bid-ask spread. In the words of its abstract, this holds "even when the specialist is risk-neutral and makes zero expected profits." In other words, part of every spread is the price of trading with people who may know more.
What this means for the price you see
A displayed quote is the current offer, not a guaranteed fill. It can change before your order arrives. A larger order can also exhaust the size shown at the best price and fill partly at worse prices. A wide spread usually means one of three things: the asset is illiquid, it is volatile, or the dealer sees a higher risk of trading against better-informed flow.
Gross spread on your own trade
What is the gross spread on the number of shares and prices you enter?
| Shares traded | Price the firm buys at | Price the firm sells at | Gross spread |
|---|---|---|---|
| 1,000 shares | 9.5 USD | 9.6 USD | 100 USD |
| 1,000 shares | 9.5 USD | 9.6 USD | 100 USD |
| 1,000 shares | 9.6 USD | 9.5 USD | -100 USD |
- Shares is your own figure; LuxAlgo's hypothetical uses 1,000 shares.
- Prices are LuxAlgo's hypothetical $9.50 buy and $9.60 sell.
- The second row swaps the prices to show a sale below the purchase price. It is a reader scenario, not LuxAlgo's example.
- Fees and other costs are not included.
The result is gross, before fees and other costs and before losses on other inventory, so it does not predict any firm's results.
The rules that apply
EU: algorithmic market making under MiFID II Article 17
Article 17(4) of the EU's Markets in Financial Instruments Directive II (MiFID II), as ESMA reproduces it, describes when an algorithmic trading firm is pursuing a market making strategy. That applies when, as a member or participant of one or more trading venues, its strategy, when dealing on own account, involves "posting firm, simultaneous two-way quotes of comparable size and at competitive prices." The aim of those quotes is "providing liquidity on a regular and frequent basis to the overall market."
Under Article 17(3), "An investment firm that engages in algorithmic trading to pursue a market making strategy" must, "taking into account the liquidity, scale and nature of the specific market and the characteristics of the instrument traded":
- "carry out this market making continuously during a specified proportion of the trading venue's trading hours," "except under exceptional circumstances";
- "enter into a binding written agreement with the trading venue" setting out those obligations;
- "have in place effective systems and controls to ensure that it fulfils its obligations under the agreement."
US: best execution under FINRA Rule 5310
FINRA Rule 5310(a)(1) covers any transaction "for or with a customer," so it applies when the firm acts as agent and also when it trades as principal against the customer. The member "shall use reasonable diligence to ascertain the best market for the subject security" so that "the resultant price to the customer is as favorable as possible under prevailing market conditions." The factors listed for reasonable diligence are:
- "the character of the market for the security"
- "the size and type of transaction"
- "the number of markets checked"
- "accessibility of the quotation"
- "the terms and conditions of the order which result in the transaction"
FINRA's page lists the most recent amendment as SR-FINRA-2014-023, effective May 9, 2014.
When "market maker" is a cover: the 2024 crypto cases
On October 9, 2024, the SEC charged three firms it called "so-called market makers": ZM Quant Investment Ltd., Gotbit Consulting LLC and CLS Global FZC LLC. It also charged nine individuals (SEC press release 2024-166). The SEC alleged that the firms sold market-manipulation services to crypto asset promoters. Those services included generating artificial trading volume and manipulating prices through "wash trading," meaning self-trading, done with bots on popular trading platforms. The SEC also alleged that ZM Quant and CLS Global manipulated a token created at the direction of the FBI during a parallel investigation. These are allegations in civil complaints, not findings.
The case shows the line between the two activities. A genuine market maker takes on risk by trading with other people. A wash trader trades with itself, takes on no economic risk and produces volume that misleads buyers.
Limitations: the mechanics section draws on one vendor blog (LuxAlgo) plus two academic papers verified from bibliographic records and an abstract quoted in search results, not from the full texts. The EU text is ESMA's reproduction, not the Official Journal.
