Understanding the concepts of spread, liquidity, and order books is crucial in the realm of market making. In this post, we'll delve into these fundamental terms and explore their significance in the context of market making.
The spread refers to the difference between the bid and ask prices quoted by a market maker. It represents the cost of executing a trade and serves as a measure of liquidity. A narrower spread indicates higher liquidity and a more efficient market.
Liquidity is the degree to which an asset can be bought or sold in the market without causing significant price fluctuations. Market makers play a vital role in providing liquidity by continuously offering bid and ask prices, ensuring that there are readily available markets for buyers and sellers.
The order book displays a list of outstanding buy and sell orders for a particular asset. It provides transparency into the current supply and demand dynamics. Market makers closely monitor the order book to gauge market conditions and adjust their quotes accordingly.