Could someone please explain what a market maker does exactly. As i understand, a market maker buys from one trader/ broker and then sells on to another trader, is that correct? What i am interested to understand is, how does a market maker control/ hedge the risk of his 'product' falling in price from what he pays to what he can sell at? thanks
In a nutshell, a market maker is someone who trades for their own account. They don't really care to much who they're trading with. They're generally interested in earning their profit from the bid/ask spread, not necessarily speculative price moves. They can control risk via having offsetting positions in related markets, using options and/or futures or merely keeping their position size small relative to what the market depth is.
A market maker is usually obliged to trade (buy to sellers, sell to buyers), so liquidity is enhanced. They lower/rise the bid/ask and try to make some -small- amounts of money. Most people with ineffective strategies tend to blame the market makers, instead of reviewing their strategies. Typical loser behavior.