What is the importance of market making?
Market makers are important to maintaining the structure of an exchange and to ensure smooth flow of orders. The importance of market makers cannot be questioned as they bring the much-needed liquidity. Having designated market makers on exchanges is more important than ever as market structure continues to change.
The importance of market makers also comes to the forefront in markets that deal with securities that are less liquid. The topic of market makers comes up at times surrounding a market crash. For example, the May 6th 2010 flash crash that sent all the three major U.S. stock indices into a plunge.
As liquidity dries up, leaving many players exposed to their positions, authorities have proposed tight regulations for the market makers. The most important aspect is that the market makers provide liquidity in times of market stress.
Despite playing an important role, algorithmic or high-frequency trading has been eating into the share of traditional market makers. With the rise of automated trading, there is the aspect of liquidity that helps to bring stability.
But at the same time, high-frequency trading can also play a big role in facilitating for market crashes that could have been avoided.
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