How MM's Work -- By a former MM employee on RB
By: Mark47
Reply To: None Thursday, 27 Jan 2000 at 1:47 PM EST
Post # of 10658
Very intersting read !!!!
Borrowed this from another board)
I was an OTC MM for about 10 years ending in the late
80's. Since then I have been strictly an investor. Since I
have not been that up to date in MM rules I will only make
statements that I feel fairly confident are still accurate
regarding these activities. By and large most MM don't
have a clue nor do they care to learn, about the
fundamentals of the stocks they trade.
They just try to make orderly markets. When dealing with
BB stocks it is very easy for a MM to get trapped into being
short in dealing in a fast moving market. Reason being;
most of the MM's in this stock are what are called
"wholesalers" this means they don't have retail brokers
"working" the stocks.
So they have to rely on what's known as the "call" from
larger retail houses. If a "Big" retail firm like an E-trade
calls up a market maker to purchase say 5,000 shares of a
stock, they expect to get an "execution" from that market
maker. If he turns them down, or only gives a partial then
the "Big" firm will go to another MM.
If this second MM "fills the order" then that "Big" firm has a
moral obligation to continue to give future "business" in that
stock to that MM who performed (his life blood). This will go
on until he "fails" to perform and so on.
Contrary to popular opinion the "Big" firms Do NOT
neccessarily go to the "Low Offer" to fill a buy order (Or
high bid for a sell). They "Go" to who they think will perform
to fill the order and expect that MM to "match" the "low
offer" in the case of a buy (bid in the case of a sell). Even
though this MM might in fact be the "high bid" and not really
want to sell any more.
As a wholesaler he must perform or he will get a reputation
as a "non-performer" with the "Big" houses and will cease
getting "calls" which means he will soon go out of business.
I mentioned above that this activity is very significant to BB
stocks. I say this because most of the trades in these BB
stocks are "unsolicited" and are done through discount
houses.
With the above groundwork laid, let me try to explain how
market makers get short even if they like the Company;
Lets say that a stock (shell) has been lying quietly at $.25
bid $.50 offered. A limit order comes into one of the MM's
to Buy at $.50 for a thousand shares. Prior to this trade that
MM may be "flat" (neither long or short any shares). He fills
the order and is now short 1,000 shares. He may raise his
bid hoping to find a seller to "flatten" out his position. But
before he realizes it a wave of buyers have come in and
cleared out all the $.50 offers. Now the stock is $.50 bid
.75 offered. Here comes that "Big" firm he just sold the
1,000 shares to at .50 with another bid for 1000 at .75. He
makes this print. Now he is short 2,000 at an average of
.625. The market keeps moving and now its .75 bid 1.00
offered. Now he has to make a decision.
Just like investors, MM Hate to take a loss. So 9 times out
of 10 he will now sell 2000 at 1.00 making him short 4000
but with an average .81. At this time he would love to see a
seller at .75 so he can cover his short and make a few
bucks.
But instead the market keeps moving up. Now it is 1.00 to
1.25 and here comes the buyer again at 1.25. He doesn't
want to lose the call so now he needs to sell 4,000 at 1.25
to keep his break even point above the bid. Now he is
short 8,000. Market moves up to 1.25 bid 1.50 offer here
comes the buyer now he feels he must sell 8000 here
because "stocks don't go up forever".
Now he is short 16,000. And so on and so on. If the stock
keeps moving up, before he realizes it he could be short
50k or 100k shares (depending how big his bank is).
_________________________
Finally the market closes for the day and on paper he may
look all right in that his "break even" price may be around
the closing price. But now he has to figure out how to entice
sellers so he can cover this short. It is important to note that
if this happened to one MM it has probably happened to
most all of them.
Some ways MM's entice sellers; Run the stock up with a
"tight spread" in a fast market, then "open" up the spread
to slow down the buying interest. After it has "cooled off" for
a little while lower the offer below the last trade right after a
small piece trades on the offer then tighten the spread so
that the sellers feel they can take a "quick profit" by "hitting
the bid" on the tight spread.
Once the selling starts the MM's will walk it down quickly by
only making small prints on the way down with the tight
spread. Another way is by running the stock up in the
morning, averaging up their short then use the above
technique to walk it down in the afternoon.
Hopefully after doing this for several days, it will demoralize
the buyers. The volume will dry up and the sellers will
materialize thinking that the game is over.
Contrary to popular opinion, MM usually Do Not Cover in
Fast moving markets either Up or Down if they are short.
They Short More. They usually try to cover after the frenzy is
out of the market. There are many other techniques they
use but the above are the most popular.
This technique works about 9 times out of 10 particularly in
a BB market. However that is because 9 out of 10 BB
stocks are BS. Remember what I said above. Most MM's
don't have a clue as to the value of a Company until they
get trapped. If the Company has solid fundementals and a
bright future. Then the stock will do very well. And the
activity that caused the situation will prove to even help the
future stock activity because it created an audience."
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Credit for this post goes to Cardshark_1999
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