By Matt Levine – There’s a social benefit in having liquidity providers who are willing to take risks. The idea is that, in the olden days, NYSE specialists were supposed to step in to keep markets orderly, buying for their own account — at their own risk — when everyone else was selling. This reduced volatility and increased public confidence, as people felt that markets would be stable and they’d always be able to trade at a reasonable price.
That system is mostly gone.
If a stock doesn’t trade very much, then you can’t make very much money quoting it — but you can lose a lot of money if the price moves away from you. So you manage your risk by quoting only small sizes, and moving your quote very rapidly if someone trades with you. Or by just not quoting the stock. So low natural liquidity — low interest from fundamental buyers and sellers — leads to low profits for market-makers, which leads them to be very jittery in making markets. more> http://tinyurl.com/nqytpy9