A lot of interesting OTCBB trading information here:
ragingbull.lycos.com
By: SonicDude $$$$
Reply To: 20632 by MONEYMADETRADER $$$$ Thursday, 1 Mar 2001 at 8:31 AM EST
Post # of 20999
HOW NOT TO GET SCREWED BY MARKET MAKERS!
MAKING MONEY IN MICROCAPS by Peter Kertes: Part I:
Anyone who frequents stock chat-sites has seen a great number of posts about the dreaded MM's - the Market Makers - who seem to be the illegitimate children of Darth Vader and whose mission in life seems to be thwarting the money-making masses in their quest. The truth is not nearly as interesting, and we felt that a short background on how and why the MM's do what they do would be in order.
The "unlisted" market - which is a misnomer, for sure - is tiered into:
1. the NASDAQ, comprising a couple of thousand of the largest OTC stocks, subject to a number of requirements on net worth, reporting status and price, and traded with real-time, firm quotes and generally
small spreads.
2. the OTCBB (Bulletin Board) stocks, greater in number, smaller in size, traded with "subject" quotes and without reporting requirements.
3.the "Pink Sheets" - from the color of the paper this list has been printed on since age immemorial - the
smallest stocks, for which no NASDAQ member filed a BB registration form, a list that comprises a lot of semi-private companies, semi-dead companies, semi-smelly companies and a whole bunch of shells (picture
a huge, pink swamp...).
Unlike the large exchanges that use "specialists", the OTC market uses Market Makers, investment firms with varying degrees of brokerage operations and a group of OTC traders who try to make money trading stocks that they choose to specialize in (and have in inventory in varying amounts). Picture a boiler- room full of crazed 29 year-olds -of every other human stripe - high on caffeine, funny, banging loudly on their phones,plus couple of grizzled veterans who are their ring-masters. What are their goals ?
1. ORDERLY MARKETS. Yes this is their secondary goal. Their primary goal is making money for the firm. They will inventory stocks that they have a good feel for, that are relatively liquid, on which they will not be caught with their pants down. Thus, the spread of a stock, reflecting the bids and offers of all the MM's of that stock, will be a picture of the size of traffic, of quality of information, of "buzz" (rising and falling, especially now with the proliferation of "pump'n'dump" and know-nothing chat-boards) and, most importantly, inventory levels. When a spread expands, the MM's are running low on inventory and they don't want to get caught in a squeeze (short or long) if Charley Schwab showed up wanting to buy 100,000 shares. Which brings us to #2.
2. FILL ORDERS. A market maker wants brokerage firms to do business with them and to come back to them again and again. This means that they will often buy or sell much more stock than they have, leaving
them with a net long or short position temporarily. In an orderly market, the MM's can use the spread to his advantage and "square" his position. The exception is when the stock is a fast mover and they end up over-extended and at great financial risk. This is when #3 comes in.
3. WALKING A STOCK. Market Makers are a club, who look out for each other, even as they compete with each other. They know very quickly when one of their ilk is caught with a major imbalance. Through the subtle signal of spreads,sizes and through negotiated telephone buys and sells with the firm in question, stocks are allowed to move up and down to a level where the troubled MM can square his position and his
brethren can take advantage - but no too much ! - of his miscalculation. This happens all the time, and imbalances can last for days. Active penny-stock traders complain when a fast-riser is being held down or "walked down", but these MM's are the same people who put the stock to them - from long inventories or a willingness to short - when they were looking for size to buy. So, go a little easier on them, they're not the enemy - it's OK to feed the animals in the zoo...
A few good ways to avoid being on the receiving end of the MM's strategies:
1. do not chase stocks, you might be the last guy holding the bag,
2. make sure you know what you are buying or selling, i.e. get real info, not "tips" and "hype".
3. avoid stocks with big spreads, the information may be bad or bogus.
4. do not short micro-caps, because stocks with small floats can move like lightning either way.
Two sites that I find helpful:
otcbb.com About OTC Bulletin Board
will give you useful info about the Bulletin Board and will be an multi- purpose portal you will use often, and
otcbb.com Daily
List will give you a list of symbol changes and moves, up and down, between the 3 OTC markets.
Disclaimer:
Global Minerals and Technologies (GMT) newsletter.
MAKING MONEY IN MICROCAPS by Peter Kertes: Part II:
Investing in large-caps, aside from all other considerations, has one significant advantage over small-caps: there is a great amount of credible public information available from these companies and there are many analysts who enhance, analyze and qualify that information, sometimes putting their own bonuses on the line (perish the thought !). By contrast, the only information that microcaps often put out are their SEC filings, if we're lucky enough to get them, low-flying PR and other flotsam and jetsam sloshing around in the murky waters at bottom of the sea, where we all try to feed in search of profits. A direct consequence is our need to resort to other analytical tools to infer the usual Buy/Hold/Sell/Dream-On decisions that we need to make on a daily basis. Let's see what we can learn from the "action" in a micro-cap.
Our analytical tools fall into 4 categories: (1) the volume, (2) the spread, (3) the speed of the price movement and (4) the "digestion" of a given dramatic move.
THE VOLUME is as good and as reliable a precursor of a price move as there is. Large volume on a bullish (accumulation) chart signals an imminent breakout (SHAL, TRMB). When you see steady, high volume, the smart money is moving into the stock (the strong holders), and you want to hitch a ride on that train. On the flip side, high volume after a series of lower highs and a flat support line precedes the breakdown (DPRC). Watch out below ! I suggest you never look at a chart, whether you like its looks or not, without glancing at the volume bars - you may come away with quite a different opinion of that stock once you took that second look.
THE SPREAD is the love language of the market-makers, and we will only speak it poorly, no matter how hard we stare at our Level II screens. That's because they also talk to each other on the phone, not just negotiating transactions between each other but also strategizing. A few rules of thumb: when the spread widens (especially the "best spread"), you can assume that overall inventory levels have dropped and the MM's are looking for stock, and looking to expand their profit margins to reflect the grater risk of getting caught short or "with their pants down". Also, if a stock that has a normal 10-15% spread makes a large move and the spread narrows, you can assume that the move is not over, since the MM's are still "liquid" in the stock. The end of the move will be signaled by a widening of the spread. More fundamentally, if a stock sports a huge spread - 30-50% - on a regular basis, that's a tar-baby, one that no MM or large player is interested in; the chances of you making any money in the stock are almost nil, not only because of the costly spread but because no one is paying attention, no matter what the news might be in the future. Find someone else's sandbox to play in.
THE SPEED OF A MOVE tells volumes about the kind of stock you're in, even if your research did not provide information about the float and the number of "strong" holders (long-term minded people, familiar with the company, and often close to its insiders). A stock that moves like a hot knife through butter is great if you own it, but you have to be 100% sure that there is a valid corporate reason for the move, otherwise that price can move just as quickly the other way. Punch up the chart of almost any microcap and you will see one or more big-time spikes that had no follow-through, and apparently had no reason other than B.S. spread by someone. Often, a few sharp operators will provide credible-sounding pseudo-information for the simple purpose of sucking in those who might think they are seeing a flag or a major breakout. Look at UPRD, moving from 1c to 47c in a week, even though they haven't released any news since November and the stock gave every indication of being what I call a"GOOB" (Going Out of Business). I don't wish for a second that I had bought that stock, even at 2 or 3c, because I might have been the greater fool holding the bag at the end of the bronco-ride. Plenty of other fish in the sea, tasty ones too....
A stock will always CONSOLIDATE for a time after a major move, up or down, and the microcap investor needs to decide if the period will be short enough to stay with the stock or long enough to sell and possibly buy back in later. Flag patterns are a classic example of this, and there are profits to be made, even after the first flag. You'll want to buy the first flag on a stock, which is usually followed by a series of flags (ALMI), but you'll want to sell a sagging flag (IMON, the last one on ALMI). Generally, the time-frame of the consolidation or flag will be proportional to the size of the move, especially if the volume settles into a steady pattern as the flag develops. Keep in mind, however, that the volume will expand for no more than 2 or 3 days before the stock rockets up to form the next flag, so if you like the stock and don't own it, you want to keep a sharp eye on the volume. You may jump in too soon, if there's a false alarm, but at least you'll be back in a stock you like.
How Not to Get Screwed by Market Makers
So you've picked a stock you want to buy. It trades on the Nasdaq. You place your order and realize a minute later that you could have bought the shares for a fraction less. You feel ripped off.
Of course, if you are a long-term investor 'teenies and eighths' - 1/16ths or 1/8ths aren't going to matter. But in a
volatile market, if you are trying to make a quick trade, this makes all the difference in the world.
Like this Article?
Was there anything you could have done to get the stock for less? Chances are the answer is yes. To do this, however, you would have needed patience and skill, and a bit of luck when placing your order with your broker.
First off, it helps to understand that your broker - - whether it’s a full-service firm like Merrill Lynch or Salomon Smith Barney, a discount broker like Charles Schwab or Waterhouse, or an online broker like E*Trade or Ameritrade - will ultimately place that order with a market maker.
What is a Market Maker?
Most of the investment banks on Wall Street make markets in a list of stocks. That means they’re willing to buy or sell the stock of a specific company at a stated price, and typically they’ll assign one professional or a small team of
them to make the market in each issue on their list.
The market maker serves the same function for over-the-counter stocks as a specialist on the floor of the New York Stock Exchange. The market maker facilitates trading in a Nasdaq stock or group of stocks by guaranteeing liquidity to the market. He or she makes a profit by buying stock from you at one price and selling the shares at a higher price. Market makers rarely hold a position overnight but under some circumstances hold a stock longer if it has the potential to generate a sizeable profit.
If, for example, you ask for a quote from your broker for XYZ company, and he or she says the market is $10 - $10.25, 10x5, this means that a market maker is willing to buy 1000 shares at $10, or is willing to sell you 500 shares at $10.25.
So how does this affect the average retail investor?
It’s not uncommon for a market maker to take 3% of your money on the way in to a stock and 3% on the way out. If you are one of those happy-go-lucky day traders sitting at your PC at work and trading a volatile stock like Yahoo! Inc. (NASDAQ: YHOO - Quotes, News, Boards) and like to place 'market orders' at $7 per trade through your favorite online broker, chances are you are not getting the best deal.
How could this be?
Easy. Suppose you place an order to buy Yahoo! at $118. If you haven’t placed any restrictions on the transaction, it’s automatically classified a "market order." That means that when the market maker receives your trade from the retail broker, he or she fills it at the current market price, even if the stock has moved against you. In five minutes, which can be an eternity with some volatile issues, you could pay an extra three points a share.
Even if the stock is on the way back down to $118 by the time you get your confirmation, you could be in the hole for $3 on each of the 1000 shares you just bought. Your investment portfolio is starting out with a deficit of $3,000
and you’ve barely begun. Welcome to this century's great bull market!
But it gets worse.
Some market makers (not all) will get your market order at $118, buy the stock and wait to see where it runs before
printing a report. If it goes up two points, guess what? Sad to say, there are some unsavory professional traders who
will buy the stock at $118 for their own trading account but sell it to you at $120. Securities regulations prohibit this
practice, but it’s all but impossible to enforce.
To defend against this, investors can place 'limit orders' with their retail brokers. This tells the market maker that you’re willing to buy or sell at the limit price or better. This means that your transaction might not get executed at all, but at least you won’t lose money to unseen forces.
In addition to a limit order, a vigilant investor can demand a 'status check' or even cancel an order if it hasn’t been
executed in a timely fashion. Another problem with market makers is that they often don't show the true size of stock that is available to buy or sell.
What does this mean?
Remember the above example of $10 - $10.25, 10x5? A logical person might conclude that the market maker might only honor 1000 shares at $10 or sell you 500 shares at $10.25.
But market makers will often show size on the bid to make it look like demand for the stock is strong, but instead be
selling their inventory out the back end. In other words, the 500 shares displayed at the offer price might represent a
position of 5000 or more. In this instance, an individual investor will buy 500 shares at $10.25 and the 10x5 size
would not change. This indicates that the market maker has a large position he or she wants to unload before the market detects selling pressure.
Look out for this practice in the afternoon. As most sessions get near the closing bell, market makers look to liquidate their positions for the day.
How can you defend against this?
Pay close attention to the day’s trading, or, if you’re using a full-service broker, ask him or her to let you know how many market makers there are in a stock, the positions they’re taking and the sizes of their orders.
But there are other problems.
Some stocks are thinly traded and can be very volatile. If a stock only has three or four market makers, just a few
thousand shares that cross the tape can have a dramatic impact on your investment position.
How can you defend against this?
Be wary of stocks that have a large spread between the bid and offer. This indicates a lack of trading volume. If your broker says there are only a couple of market makers in the issue, or the firms are not reputable, then find another stock to trade.
Market makers are hardly bad by design, nor are they out to get the individual investor. They serve a necessary function in the market and they guarantee liquidity when trading is light.
But sometimes, although they are professionals, their training and experience is no better than that of the savvy
individual investor. It’s hard to detect this inexperience from the outside, but it does present an opportunity to make
money. How? On high volume stocks like Yahoo or Intel Corp. (NASDAQ: INTC - Quotes, News, Boards), a firm
might have a market maker responsible for trading just that one issue.
Most of the time, however, a market maker and his or her assistant might be handling 20 stocks. These people are not always able to adjust quickly to changing market conditions, particularly when news is released. This may come as a shock, but traders are human, too, and they make mistakes.
They don't always have access to the most up-to-date information posted on Bloomberg, the Internet and the chat
boards. When rumors, or actual news is moving a stock, an individual investor with quick reflexes can buy a stock or stock option at a price that’s less than the news might suggest.
There’s also the potential for arbitrage, or buying shares on one exchange with the intention of selling them on another. Market makers get big salaries to react quickly, but sometimes they’re a bit slow. If they leave their terminal for a minute or two, even if they’re just grabbing lunch or heading to the bathroom, it can cost them money but open a brief window for the individual investor.
Remember, if a market maker is showing a willingness to buy 1000 shares at a price and to sell 500 shares at
another, that promise must be honored if the market maker is 'hit' with stock.
The most likely time to find a market maker asleep at the wheel is near a big holiday such as Christmas or Labor Day weekend. Like the rest of the human race, traders want to get an early jump on long weekends, and sometimes they’ll pass their 'list' (stocks they make markets in) to their assistants.
The assistants are by no means dumb, but they are often rookies at professional trading. Their inexperience leaves
them no better at judging markets than the sharp individual investor. At these holiday times, you may find it easier to trade at a price that’s more favorable, all else being equal.
Bottom Line:
Market makers usually have the distinct advantage of buying a stock for less than you can get it and selling it for more than you’ll receive. But some of the tips in this column can protect otherwise savvy individual investors from the most common tricks of the trade.
The three share-related terms commonly encountered by investors are authorized shares, outstanding shares, and the float.
Authorized shares are the whole kit and caboodle -- the maximum number of shares of stock that a company may legally create under its Articles of Incorporation. Authorized shares can only be changed by shareholder approval. (And you thought your shareholder voice didn't count!) There are generally more authorized shares than any other type. By keeping the number of authorized shares higher than those actually issued, management can always sell more shares if they need to raise additional funds or make an acquisition. Those extra authorized but unissued shares also come in handy when employees exercise their stock options.
Outstanding shares are the number of shares of stock that have been issued. It includes restricted shares (insider holdings that can't be sold without SEC notification or are under some other kind of sales restriction) and shares held by the public (see float below). Outstanding shares are used in the calculation of things like market capitalization (price times shares outstanding), book value (usually expressed as a dollar amount per share), and the ever-popular EPS (earnings per share). This is the number that really matters.
The float is the number of shares floating around in public hands that are available for trading. The formula for finding the float is: outstanding shares - restricted shares = float. |
