Market Makers

God gave us one face, but these guys have two!

When an exchange facilitates trading of a particular security, it has to ensure that there is a fair bit of and a reasonable market available for those securities. For this, it established the concept of market making. In this, the exchange appoints people who's sole job is to ensure enough amount of liquidity in the market for each security. Sometimes, a trader wants to buy a particular stock but  doesn't have opposite party to trade with or vica versa. In such cases, it is the job of market makers to enter both buy and sell side quotes to ensure that such a scenario does not occur. Thus they are "enabling a market" for a security on the exchange. Most of the exchange typically appoint specialists for the job of market making. These specialist firms get some form of rebate from the exchange since they create a market for them. This rebate may include things like giving a quarter of a penny on every share traded, off. Although traditionally, market makers used to be exchange appointed specialist firms (sell-side firms) offlate, even buy-side firms are allowed to use their super computers (read as mean machines!) for this purpose. These "new market makers" may get added provisions from exchange to perform what is called- naked short sell (selling without owning and more imp without even borrowing).
However, above said, market makers are not god-sent-angels to give their services without any personal intent. The way they look to make money in this business is by capturing the spreads between their deals. In simpler terms, if a market maker bids 10.50 for GOOG scrip and asks 10.55 for the same GOOG scrip. Then if he manages to strike a deal at 10.50, then the next thing he does is to sell it off at 10.55 and thus pocket a cool 0.05 per one stock transaction. This, he does for a million times in a day! The risk, as is apparent, over here is that he may not be able to sell the scrip immediately but after some time delay, which may land him in a not-so-good deal. however, with the advent of the mean machines in this business, smart algorithms are used for market making which ensures that they land on the greener side more often. To summarize, market makers help exchange -

1. To ensure enough  liquidity in the market
2. Act as buyers for sellers and vica versa
3. To ensure that the prices of each security is maintained within its fair limits by reducing the market impact of abrupt movements on the price of a stock.