GLOSSARY DEEP DIVE

Market Makers: Who Is Actually on the Other Side of Your Trade

When you tap buy on a brokerage app and the trade fills in under a second, someone had to be standing ready, at that exact instant, to sell you those shares. Market makers are the firms whose entire business is being that someone, continuously, all day, and understanding what they earn for doing it explains a real, if often invisible, cost built into every trade you place.

Deep dive9 min readUpdated 2026
In this article

The core principle

A market maker is a firm, typically a specialized trading firm rather than your retail broker itself, that continuously quotes both a price at which it will buy a security, the bid, and a price at which it will sell that same security, the ask, standing ready to transact on either side at essentially any moment during trading hours. This continuous two-sided quoting is what creates liquidity: the practical ability to buy or sell instantly, without waiting around for a matching counterparty to happen to show up at the same time you want to trade.

Market makers are compensated for taking on this obligation through the bid-ask spread, the gap between the price at which they buy and the price at which they sell. If a stock's quoted bid is $74.98 and its ask is $75.02, a market maker who buys a share at $74.98 and immediately resells it at $75.02 pockets $0.04 on that single round trip, a figure that looks trivial until multiplied across the enormous trading volume that flows through liquid markets every single day. The formula is straightforward: spread revenue per share ≈ ask price − bid price, collected repeatedly across an enormous number of shares traded.

Key idea A zero-commission broker does not mean a zero-cost trade. The bid-ask spread is a separate, often invisible cost baked into the price you actually receive or pay, distinct from any commission the broker charges, and it exists in every trade regardless of what your brokerage statement shows as "fees."

Competition among market makers is what keeps spreads tight in heavily traded securities: when multiple firms compete to quote the best bid and ask for a popular stock, the spread narrows toward a few cents or even fractions of a cent, because any market maker quoting a wider spread than a competitor simply loses the trade to whoever is quoting tighter. In thinly traded securities, by contrast, fewer market makers are willing to take on the risk of holding an illiquid position, so competition is weaker and spreads widen substantially, sometimes to a percent or more of the security's price, a real cost that has nothing to do with a broker's stated commission structure.

How the math works

Example 1: the dollar cost of a spread on a liquid stock. Suppose you buy 200 shares of a large, heavily traded stock quoted with a bid of $148.96 and an ask of $149.00, a four-cent spread typical of a highly liquid name. Buying at the ask and immediately, hypothetically, selling back at the bid would cost you 200 x ($149.00 − $148.96) = 200 x $0.04 = $8.00, or about $8.00 / $29,800 ≈ 0.027% of the trade's value, a cost small enough to be genuinely negligible for most long-term investors trading occasionally.

Example 2: the same trade in a thinly traded security. Now suppose you buy 200 shares of a small, thinly traded ETF quoted with a bid of $41.20 and an ask of $41.80, a 60-cent spread reflecting weaker market maker competition and lower trading volume. The same round-trip cost is 200 x ($41.80 − $41.20) = 200 x $0.60 = $120.00, against a trade value of roughly $8,360, or about $120 / $8,360 ≈ 1.44% of the trade's value, fifty times higher in percentage terms than the liquid-stock example, and considerably larger than the expense ratio most investors carefully shop for when choosing a fund. A wide spread on a thinly traded security can dwarf the ongoing annual cost of holding it, particularly for an investor who trades in and out more than once.

Key idea Spread cost scales with how often you trade, unlike an expense ratio, which accrues regardless of trading frequency. A buy-and-hold investor absorbs a spread cost once, on entry and eventually on exit; an active trader in a thinly traded security pays it repeatedly, which can quietly erode returns far more than a headline commission figure of zero would suggest.

How it shows up in real portfolios

For long-term, buy-and-hold investors in broad, heavily traded index funds and large-cap stocks, market maker spreads are a minor, largely forgettable cost, often a few hundredths of a percent, dwarfed by other factors like fund expense ratios and taxes. The picture changes meaningfully for investors trading less liquid securities: small-cap stocks, niche or newly launched ETFs, and thinly traded corporate bonds, all of which can carry spreads many times wider than a large-cap stock or a popular broad index fund.

Consider a high-earning professional, a 52-year-old business owner who periodically rebalances a $2.1 million portfolio that includes a modest allocation to a specialized, low-volume sector ETF with a typical spread of 0.8% of its price, alongside core holdings in broad index funds trading at spreads under 0.02%. Each time this investor rebalances into or out of the specialized ETF, a $50,000 trade, the spread alone costs roughly $50,000 x 0.008 = $400 per round trip, compared to under $10 on an equivalent trade in the core index holdings. Rebalanced twice a year over a decade, that single niche holding's spread cost alone could total in the range of $8,000, a cost that never appears as a line-item fee on any statement but is fully embedded in the execution price every time the position is traded.

Modern market making is heavily automated, dominated by high-speed trading firms using algorithms to update quotes continuously in response to order flow, news, and price moves in related securities, often many times per second. This automation is a major reason spreads on popular, liquid U.S. stocks and ETFs have narrowed substantially over the past two decades compared with the wider, more manually managed spreads of earlier eras, a genuine structural benefit to ordinary investors even though the same firms' speed advantages have also drawn scrutiny over practices like being able to react to order information marginally faster than other market participants.

Actionable breakdown

  • Check the bid-ask spread before trading an unfamiliar security.
    • Wide spreads signal lower liquidity and higher hidden cost.
  • Favor liquid, widely traded stocks and funds when possible.
    • Competition among market makers keeps their spreads tight.
  • Use limit orders on thinly traded securities.
    • Controls your execution price against a wide spread.
  • Minimize trading frequency in illiquid holdings specifically.
    • Spread cost repeats with every round trip taken.
  • Remember zero commission does not mean zero trading cost.
    • The spread is a separate, real, embedded cost.

It is also worth understanding payment for order flow, a common arrangement where a retail broker routes customer orders to a specific market maker in exchange for a small payment, a practice that helped make zero-commission trading commercially viable. This does not necessarily mean retail investors receive worse execution; regulations require brokers to seek reasonably good execution regardless of payment arrangements, and many retail orders in liquid securities are executed at prices at or better than the publicly quoted spread. It does mean the market maker relationship is more layered than a simple bid and ask, with the broker's own order-routing incentives forming part of the picture behind every trade.

Common pitfalls

Because spreads never appear as a labeled fee on a brokerage statement, they are easy to overlook entirely, even by otherwise careful, cost-conscious investors.

  • Assuming all trading costs are captured by a broker's stated commission, when the bid-ask spread is a separate, often larger, cost in less liquid securities.
  • Mistaking a wide spread and a low bid price for a bargain, when the gap usually reflects genuine illiquidity risk rather than an underpriced opportunity.
  • Trading small or niche ETFs frequently without checking their typical spread, which can erode returns considerably more than their advertised expense ratio.
  • Placing market orders in thinly traded securities, which can execute at the full width of the spread or worse during a fast-moving moment.
  • Bid-ask spread: the specific gap market makers profit from and traders pay on every transaction.
  • Bid: the price a market maker is currently willing to pay for a security.
  • Ask: the price a market maker is currently willing to sell a security for.
  • Liquidity: the broader concept of how quickly and cheaply an asset converts to cash.
  • Market order: the order type most directly exposed to a wide bid-ask spread.

The bottom line

Market makers keep trading fast and continuous, and the bid-ask spread they earn for that service is a small, usually forgettable cost in liquid securities that can grow surprisingly large the less liquid a security becomes.

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