When you click buy or sell, your order rarely waits for a human on the other side. It usually meets a firm that is willing to hold the opposite position for a moment, or a fraction of a second, and earn a small edge on the difference between the buy and sell price. That firm is often a market maker, and increasingly it is an automated one.
The short answer: a mix of market makers and high-frequency trading firms takes the other side of most retail trades. They provide liquidity, they get paid for it, and the price you receive reflects that arrangement. Whether that is good or bad for you depends on the order, the venue, and how you trade.
What a market maker actually does
A market maker quotes two prices at once: a bid where it will buy and an ask where it will sell. The gap between them is the spread, and capturing part of that spread is the core business. To do this safely, the firm holds inventory for short periods and tries to avoid getting picked off by someone who knows more than it does.
This is not charity, because the market maker accepts the risk that prices move against its inventory. It manages that risk with speed, hedging, and position limits, so when volatility rises, spreads tend to widen as the risk of holding inventory rises too. You see this in thin stocks and around news events.
A traditional specialist on an exchange floor and a modern electronic market maker do the same job with different tools. The electronic version quotes continuously across many stocks and adjusts prices rapidly.
Consider a simple example. A stock’s last trade is $50.00. A market maker might quote a bid of $49.99 and an ask of $50.01. If a seller hits the bid and a buyer lifts the ask in quick succession, the market maker earns two cents per share while ending flat. In practice, the two sides rarely arrive in perfect pairs. The market maker may buy at $49.99 and hold the shares for several minutes while the price drifts. If the stock falls to $49.95, that inventory is now a loss. The spread must cover the cost of doing business plus the average loss from inventory that moves the wrong way.
That is why market makers care so much about the composition of their flow. Retail orders tend to be small, unsophisticated, and uncorrelated with news, which makes them relatively safe to trade against. Institutional orders, particularly those from traders who may know something, are riskier. A market maker that cannot tell the two apart will widen quotes for everyone. A market maker that can identify retail flow, through the broker that sends it or the characteristics of the order, can quote tighter prices for that flow and still profit.
Hedging is the second tool. If a market maker accumulates too much inventory in one name, it can offset the risk by trading a correlated instrument, such as an index future or an ETF that holds the stock. This does not eliminate risk, but it converts a concentrated bet into a smaller, more manageable one. Position limits cap how much inventory the firm will hold at any moment, which is why a market maker may briefly stop quoting in a stock that is moving violently.
Where high-frequency trading fits
High-frequency trading is a method, not a single job. HFT firms use fast systems and colocated servers to react to price changes, arbitrage small differences between venues, and post quotes that update constantly. Some HFT firms act as market makers, while others run strategies that are closer to short-term arbitrage.
The distinction matters because people often use “HFT” and “market maker” as if they were the same thing. They overlap, but a market maker can be slow and manual, and an HFT firm can trade in ways that are not market making at all.
A classic HFT arbitrage example: the same stock trades on two exchanges. On one, the best offer might be slightly higher; on the other, the best bid might be slightly lower, creating a small price difference that HFT firms attempt to capture. A fast firm can buy on the first venue and sell on the second, capturing a cent per share before either quote changes. This kind of trade adds no lasting liquidity, but it does keep prices across venues from drifting apart, which benefits everyone who trades. Other HFT strategies react to public information, such as a change in the price of a related futures contract, faster than slower participants can.
How your order gets filled
On a US exchange, your broker routes the order to a venue. That might be a public exchange, or it might be an off-exchange venue run by a market maker or a wholesaler. Many retail brokers send marketable orders to wholesalers, who fill them at or better than the best displayed price. In the UK, retail orders typically go through brokers to exchanges or to systematic internalizers, which are firms trading against their own clients’ flow under MiFID rules.
The mechanics differ by market, but the principle is similar: a firm stands ready to trade with you, and it is compensated through the spread or through a fee arrangement. In the US, payment for order flow is a common model, where the wholesaler pays the broker for the right to fill retail orders. The UK and EU, however, restrict or ban this practice for retail clients. This changes the economics, but not the basic idea of a counterparty on the other side.
The routing decision is not neutral. A broker that receives payment for order flow has an incentive to send orders to the wholesaler that pays the most, subject to regulatory requirements about execution quality. US rules require brokers to review execution quality regularly and to disclose their routing arrangements, but the comparisons are complex and rarely read by retail clients. In practice, the competition between wholesalers has pushed price improvement upward for small marketable orders, which is one reason many retail fills come in slightly better than the displayed price. The same competition does not necessarily protect a client who sends a large or unusual order, because the wholesaler’s economics change with size and risk.
The risks you should weigh first
Execution quality is the main practical risk. A tight spread looks good, but if your order is small and the venue gives you a slightly worse price than another venue would, the difference adds up over many trades. For active traders, this cost can matter more than commissions.
There is also the risk of trading against better information. Market makers protect themselves by widening quotes or reducing size when they suspect informed flow. If you trade large orders in illiquid names, you may move the price against yourself regardless of who fills you.
A third risk is structural. Off-exchange trading means less visible liquidity on public exchanges. That can make the displayed market look thinner than the real market, and it can affect how prices form during stress. Regulators in both the US and UK have examined these questions, and the rules continue to evolve.
A fourth risk is less obvious: the speed advantage itself. When a market maker’s quote is stale by even a few milliseconds, faster firms can trade against it before it updates. This is sometimes called latency arbitrage, and it forces market makers to widen quotes or invest in faster systems. Both are costs that eventually reach end investors. The race for speed is expensive, and the expense is shared across the market.
There is also the question of what happens in a crisis. During sudden market stress, market makers may pull quotes or widen them sharply, because holding inventory becomes too risky. Liquidity that looks abundant in calm conditions can vanish exactly when it is most needed. This does not mean the system is broken, but it does mean that anyone relying on continuous liquidity should plan for the moments when it is not there.
What this means for traders
If you trade over weeks to a few months, your main lever is order type and timing. Limit orders let you set the price you will accept and may help manage execution costs. Market orders get you filled but can cost more in fast markets. Check whether your broker routes to venues that give price improvement, and compare fills across a few trades rather than assuming the cheapest commission is the best deal.
Watch liquidity around the open and close, when spreads and volume behave differently. Avoid sending large market orders into thin books. If you scalp or trade news, assume your counterparty is faster than you and price that into your expectations.
Practical steps help. First, record the quoted spread and the price you actually received for a sample of trades, then compare the two. Second, use limit orders for anything but the smallest, most liquid trades, and be willing to miss a fill rather than chase a price. Third, split large orders into smaller pieces and work them over time, especially in stocks with thin volume. Fourth, check your broker’s disclosures about routing and payment for order flow, and ask whether it offers a choice of venue. Fifth, avoid trading in the first and last minutes of the session unless you have a specific reason, because spreads may be wider and price swings may be larger then.
What this means for investors
If you buy and hold for an extended period, the identity of your counterparty matters far less than your total costs and diversification. A few cents of spread on a long-term purchase is noise compared with fees, taxes, and the performance of the asset itself.
Still, execution is not irrelevant. Large purchases in small-cap stocks or less liquid ETFs can suffer from poor fills, so using limit orders and splitting large trades can reduce that risk. For broad, liquid funds, however, the market-making system generally works well, and the spread is narrow.
The practical takeaway for long-term investors is to focus on the costs they can control. Fund expense ratios, account fees, taxes, and the frequency of trading matter more than a cent of spread. When a trade is large relative to the stock’s typical volume, it pays to use a limit order and to check the spread before sending it. For routine purchases of broad funds, the execution cost is small enough that it should not change the decision.
Conclusion: a counterparty you never see, a cost you can measure
Market makers and HFT firms are not villains or heroes in this story, because they are the plumbing that lets you trade quickly, and they are paid for it. Your job is not to outguess them but to understand the cost they add and to control the parts of execution you can control: order type, size, timing, and venue. Measure your fills, keep an eye on spreads, and treat execution as one more cost line in your process.
- What Is Trading and How Does It Actually Work?
- Settlement Explained: What T+1 Means for Your Trades
- What is leverage and how does it work in stock trading?
Frequently Asked Questions
Who is on the other side of my stock trade?
Most retail trades are filled by market makers or high-frequency trading firms that quote both a buy and sell price. Your broker routes the order to an exchange or an off-exchange venue, and a firm there takes the opposite side, usually within milliseconds.
Is payment for order flow bad for retail traders?
It is a fee arrangement, not automatically good or bad. The concern is whether the venue gives you the best available price. US rules require firms to fill at or better than the displayed best price, and the UK and EU restrict the practice for retail clients.
Do high-frequency traders make markets or just trade fast?
Both exist. Some HFT firms act as market makers, quoting continuously and earning the spread. Others run arbitrage or short-term strategies that are not market making. The label describes the method, not a single role.
How can I reduce execution costs as a retail trader?
Use limit orders when you can, avoid large market orders in thin stocks, and trade when liquidity is normal rather than at the open or around news. Compare fills across brokers instead of choosing on commission alone.
Should long-term investors care about market makers?
Less than active traders do. Spreads on liquid funds are small relative to long-term costs like fees and taxes. Execution still matters for large or illiquid purchases, where limit orders and splitting trades can help.
AI Notice: This article was created wholly or predominantly with the assistance of artificial intelligence and was published without human editorial review.
This article is for general information only and does not constitute investment advice. Always do your own research before making trading decisions.