The financial industry has many participants that play a key role in forming and maintaining the industry as it is, however, market makers sometimes fly under the radar. Yet, an event in May 2023 in European markets unintentionally showed how important these firms are to the smooth functioning of our financial ecosystem.

The Accidental Experiment

On May 3, 2023, a technical glitch hit a major European stock exchange. This malfunction prevented registered liquidity providers (LPs) – also known as market makers – from sending orders to the venue. While unfortunate for the exchange and the market makers, this incident created a rare opportunity to observe what happens when market makers suddenly vanish from a market.

The European Principal Traders Association (FIA EPTA) analyzed this event, comparing market conditions during the outage to normal trading days. Their findings are published in this paper and paint a clear picture of the vital role market makers play.

Key Impacts of the Market Maker Outage:

• Spreads Widened Significantly
  Without market makers, the bid-ask spread on affected stocks increased by an average of 1.059 basis points – a 14% jump. For traders and investors, this translates directly to higher transaction costs.
• Liquidity Dried Up
  Available liquidity at the best bid and offer plummeted to less than two-thirds of normal levels. This made it much harder for anyone trying to execute trades, especially in larger sizes.
• Higher Costs for Average Trades
  A typical €5,000 trade faced a spread 20% wider than usual. For €10,000 trades, the spread ballooned by 35%. These increases represent real money left on the table by traders and investors.
• Market-Wide Ripple Effects
  Even though only one exchange was directly affected, the impact rippled across other European trading venues. This highlights how interconnected modern markets are and the far-reaching influence of market makers.

Why Market Making Matters

The absence of market makers created a significantly less efficient trading environment. Here’s why their presence is so crucial:

• Tighter Spreads
  Market makers compete to offer the best prices, naturally tightening spreads and reducing costs for all market participants.
• Consistent Liquidity
  By always being ready to buy or sell, market makers ensure that there’s usually someone on the other side of a trade.
• Price Discovery
  Their constant activity helps markets quickly find fair prices for assets.
• Market Stability
  During times of stress, market makers often continue providing liquidity when others step back.

Implications for Aspiring Traders

For those considering a career in trading, this event offers valuable insights. Market making isn’t just about profits – it plays a very important role in maintaining healthy markets that benefit everyone. The fact that a technical glitch could have such a significant impact also underscores the critical role of technology in modern market making.

The May 2023 market maker outage provides concrete evidence of the value market making firms bring to financial markets. For anyone pursuing a career in trading, understanding the role of market makers is important. It’s not just about executing trades – it’s about contributing to the efficiency and stability of global financial markets.