What is the role of a market maker? – Claude Lessard

The role of a market maker is to enhance the liquidity of securities and improve the determination of stock prices so that there is the most efficient bilateral market possible.

“A market maker participates in the purchases and sales that take place in a security. If a small investor wants to sell 1,000 shares, for example, and the bid on the buy side is only 700 shares, the market maker can contribute 300 shares to that transaction,” says Voicu Valentir, former market maker for a major Canadian bank.

Each security listed on an exchange is associated with at least one designated market making firm and at least one trader responsible for promoting orderly trading of the security.

The directory of market makers at the Toronto Stock Exchange, for example, has around fifteen names. It includes the country’s six major banks.

The Toronto Stock Exchange emphasizes that its market makers primarily manage securities liquidity passively and only intervene when natural market forces do not provide sufficient liquidity.

The execution of small lots or lots considered irregular (99 shares or less) is thus ensured by market makers.

The Toronto Stock Exchange says guaranteed execution of small orders is “invaluable” given the increasing fragmentation of the trading environment, as well as being of great benefit to smaller firms having difficulty obtain liquidity on their stock.

When providing their services, market makers will sometimes open or close out a position quickly to protect themselves against the losses inherent in their role. However, they must respect market integrity rules and securities laws. They are obviously prohibited from generating false trading activity.

Still according to the TSX Market Making Program Guide, market makers receive compensation provided by the Investment Industry Regulatory Organization of Canada (IIROC) for trades carried out in the securities for which they are responsible in return reporting irregularities, suspicious or unusual behavior.

This is an important service for IIROC, it is specified, in a context where the computerization of market making continues to progress.

Voicu Valentir also points out that many individual market makers have been replaced by machines over the years.