MoneyMade
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Market Maker Speaks Out - 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).
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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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Credit for this post goes to Cardshark_1999 |
