A market maker is a firm or trading desk that stands ready to buy or sell a security at all times, and the bid-ask spread is the gap between the price it will pay and the price it will charge. That gap is a real cost you pay the instant you trade. Here is how market makers and spreads work, from the quote on your screen to the fill in your account.
Reviewed and updated for 2026. Every price below is an illustrative example, not a live quote. This is educational information about market mechanics, not investment advice.
Table of Contents
What Market Makers Do
A market maker quotes both sides of a market at the same time and stands ready to take the other side of your trade at either price. That obligation is what makes a market function, and it is the whole answer to how market makers and spreads work in practice.
In concrete terms, a market maker:
- Publishes a bid and an ask for a security continuously through the trading day.
- Provides liquidity so a trade can happen instantly instead of waiting for a natural match.
- Earns the difference between the two quoted prices on every round trip.
- Accepts inventory risk by holding the shares it just bought or sold.
- Adjusts or hedges that inventory so a price move does not create an outsized loss.
- Helps set the visible price by competing with other makers on the same quote.
That last point is worth pausing on. A market maker is not a passive spectator waiting for a trade to show up. It puts its own capital behind a promise to trade, and it earns a fraction of a cent on that promise thousands of times a day.
It is also different from what a broker or exchange does. An exchange running a matching engine sorts incoming orders and pairs buyers with sellers according to price and time priority. A market maker does not wait to be paired. It has already posted its own price and is standing there, ready either way. Some brokers and dealers do match a customer’s order with another customer’s order inside their own book, which is called internalisation, but that is a separate arrangement from the market making itself.
Understanding how market makers and spreads work also means accepting one useful piece of arithmetic early. The dealer is not holding your position in the hope that the price moves in your favour. It is trying to convert many small, quick spreads instead.
How the Bid-Ask Spread Works
The bid is the highest price buyers are currently offering to pay, and the ask is the lowest price sellers are currently asking. The bid-ask spread is the difference between them, and it is the amount a market maker earns on a share bought at the ask and sold at the bid.
Take a share trading around 100 dollars. If the best bid is 99.95 and the best ask is 100.05, the spread is 10 cents. Buy at 100.05 and sell at 99.95 and you are 10 cents poorer before fees. On a single share that sounds trivial. On a 200-share position that same in-and-out trip costs you 20 dollars.
Here is the same share priced with three different spreads. The figures are illustrative.
| Spread type | Best bid | Best ask | Spread in cents | Spread as a share of price | Cost of a round trip on 200 shares |
|---|---|---|---|---|---|
| Narrow | 99.98 | 100.03 | 5 | 0.05% | 20 dollars |
| Typical large-share spread | 99.95 | 100.05 | 10 | 0.10% | 40 dollars |
| Wide | 99.88 | 100.13 | 25 | 0.25% | 100 dollars |
Look at that last row. A 25 cent spread sounds small in percentage terms, but it is five times the cost of the 5 cent spread on the same security. Spread cost scales linearly while the price does not, which is why a wide spread quietly eats a short-term strategy alive.
The percentage column is the number most people actually care about. A spread of 10 cents on a 100 dollar share is 0.10%. The same 10 cents on a 4 dollar share is 2.5%, and on a thinly traded instrument it can be far worse. That is why the absolute number alone tells you very little.
The last price shown on a screen is a separate thing entirely. It tells you the price of the most recent completed trade, which may have happened in either direction and may have been struck against a different quote than the one you are looking at now.
How a Trade Moves From Screen to Execution
A trade gets from your screen to a fill through four stages: quotation, matching, execution, and settlement. Understanding how market makers and spreads work means knowing which stage your order is sitting at.
Quotation. Market makers publish a bid and an ask. The best bid and best ask form the top of the order book, the running list of resting buy and sell interest for that security. These quotes refresh constantly, sometimes many times a second.
Matching. Your order goes to the venue where that security trades, either directly or through your broker. Exchange rules give priority on two things: price first, then time within the same price. A limit order at the best bid joins the queue at that price and waits behind everything already resting there. A market order has no price limit, so it takes whatever is on offer, starting with the best ask.
Execution. The price you get is the price of the quote your order hit. It is called the execution price, and it is fixed at that moment even if the screen changes a second later.
Settlement. In US markets, most share trades settle on the first business day after the trade, commonly referred to as T+1. Your broker handles this part; you are not charged again for it, but it explains why positions do not settle instantly.
How Market Makers and Spreads Work in a Simple Order Example
Here is a worked example of why the average fill price can differ from the price you saw. A market maker is quoting a share at a best ask of 99.95, and you send a market buy order for 500 shares.
- Order arrives. Your order reaches the venue with no price limit attached.
- First fill. It takes 300 shares from the maker’s offer at 99.95. Cost: 29985 dollars.
- Maker manages risk. That maker now holds 300 shares it did not want. It hedges or sells into another venue rather than waiting.
- Quote moves. Other makers see the buying pressure and lift their offers. The best ask is now 100.05.
- Remaining fill. Your order takes the last 200 shares at 100.05. Cost: 20010 dollars.
- Average price. Total cost 49995 dollars for 500 shares, an average of 99.99, not the 99.95 you expected.
You paid 4 cents more per share than the displayed ask, about 20 dollars more across the whole order than if every share had filled at 99.95. That gap is slippage, and it happens without anyone doing anything improper. It simply means a market order takes whatever is available, in pieces, at whatever price is available at that instant.
Why a Limit Order Might Not Fill
A limit order sets the worst price you will accept, so it protects you from the example above. It brings its own catch: price and time priority. If other orders were already resting at your limit price, yours sits behind them. The quote may have touched your price without your order filling, because the available size at that level went to whoever arrived first.
Why the Spread Is Wider for Some Securities
Spreads widen when a market maker sees more risk in holding inventory or more chance of being run over, and they narrow when both risks fall. Seven factors drive almost every difference you will see.
Trading volume. A security that changes hands thousands of times a session is easy to trade in and out of, so quoting it tightly costs little risk. A security that trades 200 times a day is a different business.
Price stability. If a share rarely moves, a maker can hold a position for a long time without much pain. In a security that jumps, the same hold is dangerous.
Volatility. Fast markets widen quotes because the cost of being wrong rises. This is deliberate pricing of risk, not a signal that something has gone wrong.
Tick size and price level. Prices move in fixed increments. A 4 dollar instrument with a one-cent tick has a minimum possible spread of one cent, which is already 0.25%.
Time of session. Quotes are widest in the first minutes after the open, around scheduled news, and in after-hours trading, when fewer participants are watching.
Size of the issuer. Smaller companies have less public information and fewer participants, so quotes sit wider and update more slowly.
News and halts. A pending announcement, an earnings release, or a trading halt all widen quotes or remove them briefly.
| Factor | Highly liquid security | Moderately liquid security | Thinly traded security |
|---|---|---|---|
| Typical spread | 1 to 5 cents on a 100 dollar share | 10 to 40 cents | 50 cents or more, sometimes a wide percentage |
| Quote updates | Many times per second | Several times per second | Occasionally, or in larger size blocks |
| Order book depth | Many levels, large size at the top | A few visible levels | One or two levels, small size |
| Session behaviour | Spreads hold steady through the day | Widen noticeably at the open | Wide at open, close, and all day |
| News reaction | Widens for a moment, then normalises | Widens and stays wider | Quotes may disappear entirely |
| Typical use | Long-term holding, swing trades | Shorter holds, patient orders | Small positions, limit orders only |
If you are new to this, the practical rule is simple. Look at the spread before the position size. A wide spread on a large position is a large cost, and a narrow spread on a tiny position is a rounding error.
Market Maker, Liquidity Provider, and Market Maker Algorithm
A market maker and a liquidity provider are usually the same thing described from two angles: the firm is the market maker, and the service it provides is liquidity. The exchange is the venue that hosts the quotes and applies the priority rules. The algorithm is the software a firm uses to decide what to quote and how to hedge, not a separate participant.
Four terms get mixed up constantly, so it is worth separating them cleanly.
- Market maker or dealer. A registered firm or desk with a two-sided quoting obligation, trading on its own account for profit.
- Liquidity provider. The role itself. Crypto venues and automated market makers use the term for the same function in a different setting.
- Exchange or venue. The marketplace that displays the order book and matches resting orders under priority rules. It does not trade your position itself.
- Market maker algorithm. The code a firm runs to post quotes, size them, and hedge the inventory it accumulates.
Two further points matter. First, several market makers can quote the same security at once, and they compete on price, size, and speed. Second, most of the firms making markets today are proprietary trading firms rather than banks or brokerage houses. Citadel Securities, Virtu Financial, Jane Street, Susquehanna International Group, Hudson River Trading, and Flow Traders are all well known names in that category.
You are probably dealing with one of those firms rather than with a bank. The dealer behind your trade is rarely visible to you, and that opacity is the reason so many traders assume they are being targeted.
How Traders Try to Manage the Spread
No technique removes the spread. These habits reduce what it costs you, and each carries its own trade-off.
Use limit orders when you can wait. You set the worst price you will accept, so a sudden move against you cannot fill you at a worse one. You accept the risk of no fill instead of the risk of a bad fill.
Trade when the market is deep. Mid-session on a heavily traded security, spreads are narrowest and size is available. A limit order posted at the open on a thin name may sit unfilled for an hour.
Do not post order after order. Every new order is a fresh request for liquidity. Rewriting a price you barely moved by puts you back in the queue behind everything placed since.
Compare the quoted spread with what you actually got. The displayed spread tells you the market’s current stance. Your fill report tells you the real cost, including slippage and the spread you paid in practice.
Be honest about the trade-off. In a security trading at 2 dollars wide, no placement trick will give you a tight fill. Sometimes the cost of entering is simply the price of playing there, and the right move is a smaller position.
None of this guarantees a better price. It changes how much of the spread you pay and how much of it you give away to the market.
What Spreads Do Not Tell You
The displayed spread is genuinely useful and genuinely incomplete. Four things it does not tell you.
It is not a promise about your fill. A 10 cent spread does not guarantee you will pay 10 cents. As the order example above showed, a market order can average worse than the quote when the order is large relative to available size.
A narrow spread does not predict direction. Tight quotes mean two market makers agree the price is easy to trade right now. They say nothing about whether the price is going up or down. Plenty of sharp declines begin with excellent liquidity.
Tight spreads do not protect you from losses. The spread is a cost of trading, not a risk limit. A wrong position in a liquid security fills cheaply and then goes against you.
The spread is not your only cost. Commissions, exchange and regulatory fees, options contract fees, and the wider costs of frequent trading all sit outside the bid-ask number. On a very liquid share, fees can matter more than the spread. On a thin one, the spread dwarfs them.
Nor is a wide spread a hint about the future. It tells you that whoever is making the market wants more compensation for standing in it right now.
Frequently Asked Questions
Who pays the bid-ask spread?
You do, and so does the other trader on the opposite side of your order. When you buy at the ask and later sell at the bid, you hand 10 cents per share to whoever took the other side of each trade. That is why the spread is described as a transaction cost. It is not a commission charged by a broker; it is the difference between the two prices a market maker quotes, and it accrues every time you cross the spread.
Can the bid-ask spread change in real time?
Yes, constantly. Market makers refresh their quotes many times per second, so the best bid and best ask on your screen can change while you are reading it. Spreads widen at the open, around news releases, in volatile conditions, and after the close. This is why a price you saw a moment ago may no longer be available, and why orders execute against the live quote rather than the one you remember.
Why did my limit order not fill even though the price was reached?
Two rules explain most of it. Price and time priority mean your limit order joins the queue behind every resting order at that same price, and the available size may be taken by whoever arrived first. Your order is also a request to trade at your price or better, so it needs a counterparty willing to meet it. If the touch only grazed your price briefly, the order may never have been reached at all.
Do ETFs and individual shares use bid-ask spreads?
Yes. Every exchange-traded security, including ETFs and individual shares, trades through the same bid-ask mechanism, and that is what the price ticks on your screen represent. ETFs can be narrower or wider than shares of comparable companies. A heavily traded index fund is often among the tightest quotes available, while a sector fund or a single-stock ETF with low volume can be noticeably wider than the shares it tracks.
Do market makers control stock prices?
No single firm sets the price. Market makers compete with each other to offer the best bid and ask, and the visible quote is whichever offer and bid are best at that moment. They do set the terms on which they will trade, and regulation prohibits them from manipulating price deliberately. Where an individual market maker has been found to act against its own stated duty, cases have been pursued by regulators.
Conclusion
A market maker keeps quoting both sides, you pay for crossing the gap between them, and the wider that gap is, the more of your trade goes to the dealer on the other side. Nothing about that is hidden from you.
Start with three habits. Read the bid and the ask before you size anything, work out the spread as a percentage of the price, and then choose an order type that matches how urgent you are. A market order buys you speed and charges you the spread plus whatever slippage appears. A limit order protects your price and accepts the risk of sitting unfilled. The rest is repetition.