Designated Market Maker (DMM)

What is a market maker? Hint: he comes right after the butcher and the baker…

Okay, so…you have a lot of buyers...and a lot of sellers. And they come together G-ratedly in a market which is so big that it has to be divided into segments, or sections, or sub-groupings of a few stocks, in which the specialist trades. And that specialist volunteers their time—well, no, actually they get paid. A lot when things go well.

How are they paid? Through spread...and not warm butter. Instead, spread refers to the money value between a bid and an ask price under a market maker structure of trading securities.

Example time.

No More Wire Hangers...a, uh, plastic hanger company...is publicly traded on an exchange like NASDAQ, where buyers bid for a price to purchase, and sellers ask for a price to trade. No More Wire Hangers is bid this moment at $37.23 a share by buyers willing to buy right now at that price, and is being asked at this moment at a price of $37.31.

Note the eight cents a share difference in the share prices. That diff is the spread between the two prices...and it is worth noting that in extremely volatile stocks, the spread widens, and in boring, highly liquid stocks which don’t move much, the spread tightens or is narrower. That is, on a volatile equivalent of No More Wire Hangers, the spread might grow to 20 or 30 cents a share, whereas for a boring name that pays a big dividend and never moves much (think: AT&T)...the spread might be just four cents.

So why grow? Because a market maker in a volatile stock doesn’t want to be caught losing money on her inventory. She never wants to be punished for providing liquidity. And market makers provide liquidity for stocks, bonds, and basically anything else they think can generate revenue.

If No More Wire Hangers suddenly gapped down to $37.10, it would be likely less than the average of what that market maker paid for her "inventory."

Each time the shares trade, the market makers dip into that spread to pay their bills...and allow them to keep doing business. So that's spread. And not the type that Prince used to sing about.