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Strategies & Market Trends : From the Trading Desk

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To: steve goldman who wrote (2992)	5/5/1998 6:43:00 PM
From: Gokhan Gezmisoglu	Read Replies (2) of 4969

Great write-up Steve! I have a question. I am trying to understand how market makers make money. Sometimes it seems like they are no different than day traders out there. I can see how MMs make money when presented with a constant stream of buy and sell orders because they will just cross the orders and make the spread but what happens when there is an unbalance of buy and sell orders? What will happen when the market maker is getting thousands of market sell orders and yet there are no buyers. OK, I will try to give an example ... I am a market maker for XYZ, which is trading at 50 bid 51 offered. I have the best bid right now and my size is 10. XYZ is an illiquid stock and the only other MM on the bid side is sitting at 49. I get hit on my bid and now I have 1000 XYZ to get rid of. I do not have any in house buy order so I move to offer side and offer at 50 1/2. (can this even happen? I am sure it is legal but will the other MM that was offering at 51 be "pissed off"?) Now the market moves against me. Now the stock is trading at 48 - 50. Do I take my losses? If I hit the bid, I just lost 2K for my firm. The market is closing, do I carry this position overnight? Now can the above happen? When we see a market maker on the bid or offer side, does that mean they have an order they are trying to fill? What if they have no orders to fill? They are required to make markets so they stand to lose right? So there is such a thing as tape reading or being talented when you are a market maker because if you have no in house orders, you still have to be on the bid or offer side and at that point you are no different than a day trader trying to guess the direction of the market. So assuming the market makers stand to lose money for their firms, can we say they are making so much money from spreads when they have a stream of orders that these losses are dwarfed by the gains? thanks, Gokhan

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