![]() The SOES traders, sitting at their computers, would be able to instantly buy the stock using the “stale” quotes posted by floor traders.īecause they had to do things by hand, it might take them a minute to adjust things, but they had to honor quotes executed through the SOES system, so they were consistently getting burned. These small SOES traders had a huge advantage: the SOES system executed orders immediately, while floor traders had to manage their quotes manually.įor example, let’s say some great, unexpected news comes out for a stock. It was essentially a direct route to trade with the floor traders but was only accessible if your trade was less than 1,000 shares. One of the first significant blows to the physical trading pits was the Nasdaq SOES electronic trading system. Luke Posey on Towards Data Science drew a great visual representation of market making activities:īefore the advent of sophisticated electronic trading technology, floor traders were the primary market makers on major exchanges.įloor traders stood in large trading ‘pits,’ where they used their own hand signals and jargon to communicate with each other. Should they wind up with too much exposure on one side of the trade, many will use other instruments like options, futures, and swaps, to hedge their exposure. They offer bids and asks to both sides of the market to earn the bid/ask spread. To summarize: market makers profit by always making a market. ![]() Floor traders used to fight over 12 cents, which was the tick-size, or the smallest price change in a stock.Įlectronic market makers now fight over less than a penny. Modern-day market making is intensely competitive, requiring near-perfect execution of their algorithms. Today’s electronic market making has no physical requirements and instead is made up of the brightest minds in computer science, mathematics, and quantitative finance. Paul Research, said he was “ disparagingly told I was hired because of my 6 foot 3 height to be seen on the floor, not my intelligence – but I beg to differ.”įloor traders were rarely mathematical geniuses and instead honed market intuition through social cues from other traders in the pit and back-of-the-napkin calculations. The floor traders were tall and broad-shouldered men, often from a competitive sports background because of pit trading’s physical aspect.Īlan Knuckman, a former floor trader, writing for St. The contrast between the market maker of today and yesterday is staggering. Humans instead develop highly sophisticated algorithms and allow them to trade unfettered. Nowadays, most market making is done by computers, with little human interaction in actual trading. The process definitely wasn’t instant.Įven everyday traders can now send a digital order ticket to exchanges or electronic market makers with a button click.Ĭonceptually, the process of market making is the same today, but the venue is very different. You’d call your broker to place an order, and your broker would send one of their staffers down to the trading pit to hand the ticket to a trader. Market making used to take place in the trading pit by floor traders. They aim to capture a piece of the “spread,” which is the difference between the best bid price and the best offered price. Market makers are more like a grocery store, buying at “wholesale” prices and passing them onto their customers for a slight premium. Some trade their own account for profit, while exchanges or issuers hire others to maintain orderly trading and ensure traders can buy or sell easily.īy placing orders on both sides of the market, market makers remove most directional risk from their trading.Įvery day traders like you and I aim to buy a stock and wait for it to go up. They’re ‘making the market’ by ensuring traders can always buy or sell, hence the name ‘market maker.’ Market makers come in many forms. Market makers are highly capitalized traders who profit by providing liquidity to the rest of the market. They typically hold a lot of inventory of shares in that security so they can fulfill large amounts of orders in a moments notice. A market maker is a broker-dealer who has been certified, and/or has met capital requirements, to facilitate transactions in a particular security between the buyer and sellers.
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