Inside Market
Categories: Trading
When you want to buy a stock, you log into an online brokerage account and purchase the shares at their current market price. You don't think much about where that price comes from, but there's a whole process going on below the surface to end at that seemingly simple dollar amount.
Publicly traded financial instruments (like stocks) get priced using a system not unlike an auction. There's a bid ("hey, I'd like to buy 100 shares at $22.36") and an ask ("I'll sell 60 shares at $22.38"). In-between, there's the market maker. These professionals act like auctioneers, matching the bids and asks to set the market price for the security.
To keep liquidity, these market makers sometimes trade with each other. If there aren't enough bids or asks, the market maker may turn to another market maker to get everything to match up. This process defines the inside market. It's the behind-the-scenes moves that keep the market humming.
Highly liquid assets (like big-name stocks) usually don't require much of an inside market. There's enough interest on both the buy and sell sides to keep things going.
However, trade in some commodities and other less liquid situations might require much more inside action to keep the market stable.
Related or Semi-related Video
Finance: What is Spread?48 Views
finance a la shmoop. what is spread? before we start just no. get your mind
out of the gutter. spread refers to the money value between [100 dollar bill]
a bid and ask price under a market maker structure of trading securities. no more
wire hangers, a 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 [Nasdaq wall shown]
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 shared difference in the share prices.
that dif is the spread between the two prices, and it's worth noting that in [bread is buttered]
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 a boring name that pays a big dividend and the stock
never moves much we're thinking AT&T here, [man snores at a desk]
well that spread might be just three or four cents. so why grow? well because a
market maker in a volatile stock doesn't want to be caught losing money on her
inventory. if no more wire hangers suddenly gapped down to 37.10 a share [equation shown]
well it would be likely less than the average of what the market maker paid
for her quote "inventory" unquote in that stock from which he was making a market
in it. each time the shares trade the market makers dip into that spread to [woman dips cracker in butter]
pay their bills and allow them to keep doing business. so that's spread. and it's
not the type that Prince used to sing about. [man on stage]