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Strategies & Market Trends : Momentum Daytrading - Tricks of the Trade -- Ignore unavailable to you. Want to Upgrade?

To: paideia who wrote (1041)	5/25/1998 2:49:00 PM
From: Robert Graham	Read Replies (1) \| Respond to of 2120

NASDAQ MMs operate in a group that is lead by the "ball", the one that does most of the volume trades in a specific security. The rest of the MMs making a market in that stock fall in line with the actions of this leader. This has been noted in Forbes article on this subject. What is interesting is that there are MM that are unwilling participants in this effort of the "ball" to direct the price action of a stock. Also much of the operating practices of this "collusion" has been revealed by the SEC in their continuing investigation of NASDAQ. IMO the SEC is taking allot of time in getting around to holding the NASDAQ MM culpable for these unethical and illegal practices. As far as gaps go, a gap can be genuine. In other words, its the MM's attempt to balance supply and demand at the open. This gap is usually caused by a news event which causes an imbalance between the buying and selling interests. So IMO in a sense it is a "best guess". There is a grey area here in the lattitude that needs to be afforded to the MM. I see the MM as not being the liquidity in the market, but facilitating market liquidity where at times they need to be the one on the other side of a transaction. Setting the opening price of a stock is one way the MM manages market liquidity through their efforts in balancing of supply and demand. However, what I am saying here is that the NASDAQ MM tends to take advantage of this latitude, and at times can do this in such a way where it ends up being a blatant effort to manipulate the short term price action of a stock to generate a profit for themselves from the position they take in the stock and the unique advantage their role in the markets provide them. This tends to happen with the more illiquid issues. I do not think you will find this type of approach taken by the MM of MSFT or INTC. Now what helps (actually motivates) the MM to effectively manage the supply and demand of a stock? In other words, as an example, what prevents the MM from moving their quote into further selling when there are buyers available to buy the stock? When there is a selloff of a stock, the MM is likely to end up taking in stock in their function of taking the other side of the trade. There are choices for the MM to make at every step of the selloff. If the current selling precipitates more selling, then the MM will end up with a growing long position and an associated growing risk. What would you do in the MM's shoes to manage this risk? I personally would be at times probing for buyers to take the shares of stock off of my hands. Managing the risk of my market making function will motivate me to look for the waiting buyers that may be there willing to take this risk from my hands. Basically, what I am saying here is that IMO the effective management of the price action on a stock is facilitated by the MM pursuing their best interest as long as they continue to operate in their role as an interest that facilitates liquiidity and trade in the stock. The MM pursues their best interest by managing their position in the stock with the goal of minimizing their short or long position in the stock they make a market in. If they were not provided this leeway, no one would be willing to take on the substantial risks involved with market making. They are there to make money too by managing their risks involved with their role in the market. Furthermore, by managing their position in the stock for instance during a sell off, this can help provide liquidity to the buyers waiting to take a position in the stock. However, there is this grey area between facilitation of trading in a stock and manipulation of the trading action of a stock. So what starts out as a MM managing the risks of their function by managing their position in the stock to facilitating trade in this way, can become the MM taking advantage of their position to manipulate the stock for a profit beyond the spread, to the disadvantage of the other traders in the stock. The possibility of "collusion" and price manipulation exists when MMs are allowed to take on a vested interest in the price of the stock as part of the normal trading activity of a stock. That is why I like the specialist system much better. They step in only when they need to in order to facilitate liquidity in the market, and they also manage the execution of limit orders. Most of the stock traded in this way on the NYSE, over 70% by some estimates, goes directly between the buyer and seller bypassing the specialist on the exchange floor. Also, most business (except for instance crossed orders) occur out in the open exchange in view of the floor participants including the oversight of the specialist. This helps provide for a more fair and equitable market. All we need now for the NYSE is an electronic book that is accessible by the public. I hope I am making sense here. The above is just my own thoughts on the role of market makers. Comments and feedback welcome. Steve should be able to provide important information on this topic. Bob Graham