An interesting article on MM activity.
The following is an excellent article on MM's and how they work:
From NASDAQ BB ALERT
"Below is an essential guide to understanding Market makers on the Nasdaq
market as pertaining to all good and bad stocks and an explanation as to
how a MM NEVER QUITS SHORTING A STOCK. MM GAMES
Ways of a MM (Market Maker)
I was a 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 whats know 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 tha MM who preformed (his life blood). This will go on until
he "fails" to perform and so on.
Contrary to popular opinion the "Big" firms Do NOT neccessarly go
to the "Low Offer" to fill a buy order (Or high bid for a sell). The
"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 wholsaler 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, ergo "Big" firms. With the above
groundwork layed, 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 quitely 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 fill 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 loose 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
allright 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
spead" 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 th 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
particulary 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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