Definition
Market Making (Algorithmic)
Algorithmic market making is the automated, continuous posting of buy and sell quotes for a security to provide liquidity, earning the bid-ask spread while managing inventory and adverse-selection risk.
On Indian exchanges, registered market makers commit to two-sided quotes, especially in ETFs, options and less liquid securities, and may receive incentives from issuers or exchanges. An algo market maker constantly updates quotes based on order flow, volatility and its current inventory.
The core risk is adverse selection: getting filled by better-informed traders just before the price moves. Sophisticated market-making algos widen spreads or skew quotes when toxicity rises, and hedge inventory using correlated instruments. Reliable market making is essential to ETF liquidity and tight iNAV-to-price alignment.
Related terms
- High-Frequency Trading (HFT)High-frequency trading is a subset of algorithmic trading characterised by extremely high order submission rates, very short holding periods and reliance on ultra-low-latency infrastructure to capture tiny, fleeting price discrepancies.
- Latency ArbitrageLatency arbitrage is a strategy that profits from being faster than other participants to act on the same information, capturing price differences between venues or instruments before they realign.
- Bid-Ask SpreadThe bid-ask spread is the difference between the highest price a buyer will pay (bid) and the lowest price a seller will accept (ask), representing a core implicit cost of trading and a measure of liquidity.
- ETF Market MakerAn ETF market maker is a registered participant that continuously posts buy and sell quotes for ETF units on the exchange, providing on-screen liquidity and keeping the traded price close to fair value.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.