Understanding Market Makers and How They Affect Prices
If you are new to investing, market makers can feel mysterious because they sit behind the scenes while prices move on your screen. This guide explains what market makers do, how they influence bid-ask spreads and execution quality, and how beginner-to-intermediate investors can make smarter trading decisions because of it.
By the end, you will understand how market makers help markets function, how to spot the costs they can add to a trade, and how to reduce those costs with better order choices. If you also want to compare the impact of different trade sizes on your portfolio, you may find our investment return calculator useful for testing how small pricing differences compound over time.
What is a Market Maker?
A market maker is a financial firm or trading participant that continuously quotes both a buying price and a selling price for a security. In simple terms, they help create liquidity, which means there is usually someone available to buy when you want to sell and someone available to sell when you want to buy.
Market makers are common in stocks, exchange-traded funds (ETFs), options, and some bonds. Their role is especially important in less-traded securities, where there may not be many natural buyers and sellers at any moment.
The two prices they quote are the bid and the ask. The bid is the highest price the market maker is willing to pay, and the ask is the lowest price they are willing to sell for. The gap between those two prices is the bid-ask spread, and that spread is one of the main ways market makers affect prices.
Why Market Makers Matter
Market makers matter because they make trading possible even when other investors are not actively matching orders. Without them, many assets would trade less often, spreads would usually be wider, and investors could pay more to enter or exit positions.
For everyday investors, the biggest impact is often hidden in the spread. A stock with a $0.02 spread costs much less to trade than a stock with a $0.50 spread, especially if you trade in larger sizes or frequently.
Market quality is not just a theory. The U.S. Securities and Exchange Commission notes that market structure and order execution can materially affect investor outcomes, and the Financial Industry Regulatory Authority (FINRA) publishes best execution guidance because getting a better fill price can improve results over time. You can review current regulatory context at the SEC and FINRA.
Academic research also shows that liquidity matters. In broad terms, more liquid markets tend to have lower trading costs and better price continuity. During volatile periods, spreads often widen because market makers face more risk, which means investors may pay more to trade exactly when markets are moving fast.
Why this matters in real money terms: if you buy 100 shares of a stock with a $0.20 spread, the hidden cost can be around $20 compared with trading at a midpoint price. If you repeat that several times a year, the cost can add up to hundreds of dollars, which is money that is no longer compounding in your portfolio. If you are planning long-term contributions, our compound interest calculator can help show how small savings on trading costs can matter over time.
How Market Makers Work
Market makers post quotes on both sides of the market and stand ready to trade. When a buyer submits a market order, the market maker may sell shares from inventory or route the order to another venue. When a seller submits a market order, the market maker may buy shares and hold them until they can offset the position later.
They take on inventory risk. If they buy shares and the price falls before they can sell them, they lose money. If they sell shares and the price rises before they can buy them back, they also lose money. The spread helps compensate them for that risk, as well as for technology, staffing, and exchange fees.
Worked numerical example
Imagine a stock is quoted at a bid of $24.98 and an ask of $25.02. The spread is $0.04. If you place a market order to buy 200 shares, you may pay close to $25.02 per share, or about $5,004 total before commissions and fees.
If you instead use a limit order at $25.00 and the order fills, you save $0.02 per share versus the ask. On 200 shares, that is a $4 improvement. That may sound small, but if you make 25 similar trades in a year, the difference is $100. Over several years, those savings can be redirected into investments that grow instead of being lost to execution costs.
Now consider a less liquid stock with a bid of $24.80 and an ask of $25.20. The spread is $0.40, which is ten times wider. Buying 200 shares at the ask costs roughly $40 more than buying at the midpoint. This is why market makers affect prices more noticeably in smaller, less liquid names than in heavily traded large-cap stocks or major ETFs.
For a simple way to compare the long-term effect of different trade prices, you can also use the ROI calculator to estimate how much extra return you need to offset trading friction.
Step-by-Step Guide
Step 1: Identify the security’s liquidity
What to do: Check the average daily trading volume and the typical bid-ask spread before you place a trade.
Why it matters: Higher volume usually means tighter spreads and lower hidden trading costs. Lower volume often means wider spreads and more price impact.
Example: An ETF trading 8 million shares a day may have a $0.01 spread, while a small-cap stock trading 50,000 shares a day may have a $0.25 spread. The ETF is usually cheaper to trade.
Step 2: Look at the bid and ask, not just the last price
What to do: Before trading, check both the bid and ask prices in your brokerage platform.
Why it matters: The last traded price can be outdated. The current spread tells you what it may cost to get in or out right now.
Example: A stock’s last trade was $50.00, but the live quote is $49.95 bid and $50.05 ask. If you buy immediately, you are likely paying closer to $50.05, not $50.00.
Step 3: Use limit orders when the spread is wide
What to do: Set the highest price you are willing to pay when buying, or the lowest price you are willing to accept when selling.
Why it matters: A limit order can protect you from paying the full ask in a wide market. It may not fill instantly, but it can reduce slippage, which is the difference between the expected price and the executed price.
Example: If an ETF is quoted at $100.00 bid and $100.06 ask, you might place a buy limit at $100.02. If the order fills, you save $0.04 per share compared with buying at the ask.
Step 4: Avoid trading during the most volatile moments unless necessary
What to do: Be cautious around earnings releases, major economic announcements, and the first and last minutes of the trading day.
Why it matters: Market makers often widen spreads when uncertainty rises. That can increase your trading cost and reduce execution quality.
Example: A stock that normally trades with a $0.03 spread may widen to $0.20 after an earnings surprise. On a 500-share order, that can mean a much larger hidden cost.
Step 5: Compare the cost of trading with the size of your investment
What to do: Estimate whether the spread is meaningful relative to your trade size and time horizon.
Why it matters: A $10 spread on a $200 trade is huge, but a $10 spread on a $20,000 trade is less significant. The right decision depends on proportion, not just the dollar amount.
Example: If you invest $1,000 in a stock with a $0.10 spread, the cost may be modest. But if you are making many small purchases, those costs can accumulate faster than you expect. You can model the longer-term effect with the investment return calculator or the compound interest calculator.
Step 6: Focus on total investing costs, not only commissions
What to do: Add up spreads, commissions, fees, and any price impact from larger orders.
Why it matters: Many brokers now advertise zero commissions, but the spread can still be a real cost. Your true cost is the full execution picture.
Example: A zero-commission trade that costs $12 in spread may be more expensive than a broker charging a $4 commission but giving you a better fill.
Tips for Success
Use limit orders on spreads above 0.25%
If the bid-ask spread is wider than 0.25% of the share price, consider a limit order instead of a market order. For example, on a $20 stock, a spread wider than $0.05 deserves extra caution.
Watch the first and last 15 minutes
Spreads are often less stable in the first 15 minutes after the open and the last 15 minutes before the close. If you do not need to trade immediately, waiting can improve your fill.
Size matters
For orders larger than 1% of a stock’s average daily volume, break the order into smaller pieces when possible. This can reduce market impact and help you avoid moving the price against yourself.
Estimate the impact of trading costs
Use our Investment Return Calculator to see how small price differences can affect your portfolio over time.
Check whether your savings can support investing
Before trading more actively, make sure your cash plan is solid with our Savings Goal Calculator.
Common Mistakes to Avoid
1. Using market orders in thinly traded stocks. If the spread is wide, a market order can fill far from the last price. On a 1,000-share trade, a $0.30 spread can cost about $300 versus a midpoint fill.
2. Ignoring the spread because commissions are zero. Zero commission does not mean zero cost. A $0.15 spread on 100 shares is still a $15 hidden cost.
3. Trading during major news events without checking liquidity. Spreads can widen sharply after earnings, Fed announcements, or unexpected headlines. That can turn a normal trade into an expensive one.
4. Assuming the last price is the price you will get. The last trade is only a reference. Your actual fill depends on current bids, asks, and available liquidity.
5. Chasing fast moves in illiquid names. If a stock jumps on news but has poor liquidity, you may buy near the high of the move and then face a quick reversal. That can create immediate losses plus wider spreads.
For investors who are deciding between different strategies, it can help to compare expected returns against trading friction using our ROI calculator or read about how to use an ROI calculator when choosing between two options.
Frequently Asked Questions
Do market makers set the price of a stock?
Not by themselves. Prices are formed by supply and demand across the market, but market makers help define the tradable bid and ask around that price. Their quotes influence the price you can actually buy or sell at.
Are market makers the same as brokers?
No. Brokers route your order to a market venue, while market makers provide liquidity by quoting prices and taking the other side of trades. Some firms can perform both roles in different parts of the market, but the functions are not the same.
Why do spreads widen when markets are volatile?
Because market makers face more risk when prices can move sharply. A wider spread helps compensate them for the chance that the price moves against their inventory before they can hedge or offset it.
Is a wider spread always bad?
Usually it means higher trading cost, but it can also signal that the asset is less liquid or more uncertain. The key is to match your order type and timing to the market conditions.
How can I tell if I am getting a fair fill?
Compare your execution price with the live bid, ask, and midpoint at the time of your order. If your fill is consistently near the midpoint or better, that is generally a good sign. FINRA and the SEC both provide educational material on execution quality and market structure at FINRA Investor Insights and SEC Investor.gov.
Disclaimer: This article is for educational purposes only and does not constitute financial, investment, legal, or tax advice. Investing involves risk, including the possible loss of principal. Market conditions, spreads, and execution quality can change quickly, so consider your personal circumstances and consult a qualified professional if needed.
Last updated: October 12, 2026
Educational notice: This article is for educational purposes only and is not investment, tax, or legal advice. Read the full disclaimer.
