Market Maker: Costs, Spreads & Execution

Market makers, brokers, and payment for order flow

A market maker is not the same as a broker. A broker is the firm that receives and handles a customer order. A market maker is a firm that may provide quoted buying and selling prices and may execute against orders routed to it.

Investor.gov notes that, for an exchange-listed stock, a broker may direct an order to the listing exchange, to another exchange, or to a firm called a market maker. It also explains that some market makers pay brokers for routing orders to them, a practice called payment for order flow (Investor.gov).

Payment for order flow is often misunderstood. It does not automatically mean every order receives a poor execution, and it does not automatically mean every order receives an optimal execution. The important educational point is that order routing can involve incentives that are not obvious from the trade ticket alone. A broker still has execution obligations, but a beginner should understand that “no commission” does not mean the order path is economically irrelevant.

This article is for educational purposes only and does not constitute financial or investment advice. Finelo does not recommend any security, strategy, or transaction. Investing involves risk, including possible loss of principal.

For a broader explanation of how exchanges, brokers, buyers, and sellers interact, Finelo’s related guide on how the stock market works may be useful as general educational context.

Risks, limitations, and failure modes

Market makers can support liquidity, but they do not remove trading risk. Several limitations matter.

Quotes can change quickly. A displayed bid or ask is a snapshot. In active markets, prices may update rapidly. In stressed markets, quotes may widen, disappear, or move before an order reaches the venue.

Displayed size may be limited. A quote might show 100 shares available at the ask. If an order is for 1,000 shares, the first 100 might execute at that ask, while the rest may require higher prices. This is one reason larger orders can experience different execution outcomes than small orders.

Spreads can widen when liquidity falls. Thinly traded stocks, some OTC securities, pre-market and after-hours sessions, and volatile news events may have wider spreads. A wide spread can make entering and exiting a position more expensive than expected.

Market orders can receive surprising fills. A market order says, in effect, that execution is the priority. It does not set a maximum buy price or minimum sell price. If the available quote changes or available size is small, the fill price may differ from what the trader expected when clicking submit.

Limit orders may not fill. A limit order can provide price control, but it does not guarantee execution. A buy limit below the current ask may sit unfilled if sellers do not accept that price. A sell limit above the current bid may also remain open.

Partial fills can occur. An order may fill only in part if there is not enough available liquidity at the limit price or if market conditions change. This can leave the investor with a smaller position than intended or an open remainder.

OTC markets can carry additional complexity. Investor.gov notes that, for a stock trading over the counter, a broker may send the order to an OTC market maker. OTC securities may have less transparency, lower liquidity, wider spreads, and higher volatility than more actively traded exchange-listed stocks.

Cancellation is not reversal. If an order is open, a cancellation request may stop it from filling. If it has already executed, cancellation generally does not undo the trade. The safer educational habit is to review the symbol, order type, quantity, limit price if any, and time-in-force before submission.

Common misinterpretations

“A market maker controls the stock price.”
A market maker quotes prices at which it is willing to buy or sell, but it does not have unlimited control over a security’s value. Prices are shaped by supply, demand, available liquidity, news, risk, investor expectations, and the broader market environment.

“The market maker is always trading against me.”
A market maker may be the counterparty to an order, but that does not make every execution abusive or unfavorable. The question is whether the order received execution consistent with applicable rules, available quotes, and the order instructions.

“Zero commission means trading is free.”
A trade can have no visible commission while still involving spread costs, price movement, taxes, regulatory fees, or opportunity costs. The bid-ask spread is often the first hidden-in-plain-sight friction beginners encounter.

“The last price is the price I can get.”
The last price is historical. The current bid and ask are more relevant for estimating where a new order might execute, although even current quotes can change.

“A limit order is always better than a market order.”
A limit order can control price, but it may not execute. A market order can execute quickly, but the price is less certain. Neither is universally “better”; the tradeoff depends on the educational scenario, market conditions, and the investor’s objectives and constraints.

“Market makers matter only to professional traders.”
Even a small beginner order interacts with market structure. A learner may not need advanced trading knowledge, but understanding spreads and order routing can reduce confusion when the fill price differs from the last price seen on a quote screen.

Practical learning steps

A useful way to study market makers is to observe quotes without placing real trades. A paper-trading environment or quote screen can help learners practice the mechanics.

A concrete reading workflow could look like this:

1. Pick a widely traded stock and an infrequently traded stock for observation only.
2. Write down the bid, ask, spread, and last price for each.
3. Calculate the spread as a percentage of the ask:
   Spread ÷ Ask × 100
4. Compare the percentage spread between the two securities.
5. Observe whether the spread changes during the trading day.
6. Compare regular market hours with pre-market or after-hours quotes if available.
7. Practice estimating hypothetical cost differences for 10, 50, and 100 shares.
8. Review how a market order and a limit order would differ in price certainty and fill certainty.

For example, if a stock has a bid of $20.00 and an ask of $20.04, the spread is $0.04. As a percentage of the ask:

$0.04 ÷ $20.04 × 100 = 0.1996%, or about 0.20%

If another stock has a bid of $20.00 and an ask of $21.00, the spread is $1.00:

$1.00 ÷ $21.00 × 100 = 4.7619%, or about 4.76%

Both stocks may appear to trade near $20, but the second has a much wider percentage spread. That difference could matter more than a beginner expects.

Learners who want to practice without using real money can explore a related educational tool such as Finelo’s free stock market simulator. Simulation cannot reproduce every real-world execution issue, but it can help build familiarity with quotes, order types, and portfolio tracking before real capital is involved.

The central takeaway is that a market maker is a liquidity provider quoting buy and sell prices, not a magic price setter or a guaranteed counterparty on favorable terms. Understanding the bid, ask, spread, order type, and routing path can make order execution easier to interpret and may help learners avoid common mistakes.