The bid size is the amount of shares the MM is willing to purchase from those investors selling their stock. The ask size is the amount of shares the MM is willing to sell to investors interested in purchasing the stock. However, it rarely works this way. Remember, the MM has a vested interest in the stock they make a market in, and therefore are in business for themselves.
After careful tracking of MMs through the trading day of a closely held stock, I have come to the conclusion that the bid/ask sizes rarely reflect reality. Place yourself in the position of the MM. Why would you want to incur unnecissary additional risk by quoting substantial bid size on a down market for instance? In other words, the MM will place a quote that will minimize their committment (associated risk) to sell/purchase stock in their role as the self-interested middleman. The quotes are *minimum* amounts that the MM is willing to commit themselves to. They can always sell 2000 shares even though they quote only 1000 shares for the ask size for instance.
I find that when the MM has a substantial surplus of stock, they are reluctant to advertise this fact. They will find other means to sell the shares that will not give out knowledge of their surplus which can cause the traders to lower their bids. The MM will instead be on the phone in their attempt to place their surplus of stock. This will provide them with more control over the selling price and minimize their potential losses (or increase their potential profits). When they find this cannot be done, then if it is near the end of the day, they may wait until the next morning. However, I have rarley seen a MM hold on to stock longer than 1 hour or so unless it is an illiquid time of the day. I also see the MM as a last resort reveal the surplus they have to sell by raising the ask size of their quote on the stock until the surplus is gone. If it is a very liquid market, the MM may reveal the surplus up front in this way.
In other words, the bid/asl sizes are more symbolic than a reflection of reality. IMO the news regulations have not changed this for the most part. Since with the current system it is difficult to monitor the validity of bid/ask quotes (much of the business occurs ove the telephone), the market maker can get away with infrequent adjusting of the big/ask size through the day and still have it not reflect the current reality of the situation. I have seen this happen.
IMO there are three ways to manage the freedome the MM enjoys in playing games with the customer. One is to electronically open up their book on the stocks they make a market in. Another is to provide for a required means for all stock bid/ask information to go through the computer. In this way, an outsider can see what is occuring as far as the current bid/ask pquotes from the customers, and the associated quote from the MM. The final way to make NASDAQ trading practices more on the level is to allow the trader to participate in the "inside" market managed with Selectnet. Metter of fact, Selectnet can be the required means for everyone concerned, including the MM, to execute their stock transacitons. In this way, there would be no "inside" market of stock securities.
Any thoughts?
Bob Graham |
