What Is a One-Sided Market?
A one-sided, or one-way market is a market that occurs when market makers only quote one of either thebid or the ask price. One-way markets arise when the market is moving strongly in a certain direction.
By contrast, atwo-sided marketis one where both the bid and ask are quoted.
Key Takeaways
- A one-sided market is a market for a security in which market makers only quote either the bid or the ask price.
- A common example of a one-sided market is when market makers are offering shares in an IPO for which there is strong investor demand.
- One-way markets can also arise in situations where fear has taken over the market, such as when an asset bubble collapses.
- Market makers mitigate the risk of one-sided markets by charging a wider spread between their bid and ask prices.
Understanding One-Sided Markets
Market makers are required to maintain a two-sided market where both a bid and an ask price are shown to investors. This is known as a bid-ask spread. However, if there is great interest in a certain stock and the market maker is the only one selling, the market maker is in a position to be able to sell the shares for a very high price, and therefore only display one offer. This creates a one-sided market.
One-sided markets occur when there are only potential buyers or sellers interested in a particular security, but not both. Although these situations are relatively uncommon, they occasionally occur in relation to theinitial public offerings (IPOs)of hotly anticipated companies.
One-sided markets may also refer to situations in which the entire market is strongly heading in a certain direction. For example, say a pharmaceutical company has been researching cures for cancer and after decades of tests and experiments discovers a breakthrough that leads to the creation and patent of a cancer vaccine that is nearly 100 percent effective. This revolutionary discovery will save tens of millions of lives right away and because the invention is patented, this particular pharmaceutical company will be the only supplier.
Nearly every investor wants to buy shares of this company and nobody wants to sell. The individuals or brokerage houses that act as market makers for the pharmaceutical company have an obligation to facilitate trades and thus act as sellers. Accordingly, they only present a bid price for the shares in their inventory.
Implications of One-Sided Market
One-sided markets can be unstable and very stressful for the financial institutions acting as market makers who are obligated to facilitate trading in particular stocks, even if doing so is less cost-effective or more inconvenient.
Because of the large number of units within their inventory, market makers assume high levels of risk, and are compensated for that risk of holding assets. The risk they face is a possible decline in the value of a security or asset after it has been purchased from a seller and before it is sold to a buyer. These brokerage houses “make a market” by buying and selling securities of a defined set of companies to broker-dealer firms that are members of that exchange.
While one-sided markets may be volatile and uncertain, the pharmaceutical company example also demonstrates how one-sided markets can be quite profitable for market makers. This affects investors because when a market maker is able to sell shares for very high prices, that means investors will likely pay a very high price as well.
