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Non-Tech : Lufkin Industries (Nasdaq: LUFK) -- Ignore unavailable to you. Want to Upgrade?

To: lofalutin who wrote (98)	9/18/1998 10:37:00 PM
From: Todd D. Wiener	Read Replies (2) \| Respond to of 103

Stephen- Good question. You and I buy at the ask and sell at the bid, but the MMs do the opposite. When you try to sell LUFK, you sell it at 26.63 to the MM, who is buying at 26.63 (the bid). If someone else wants to buy LUFK, he has to pay 28.25 (the MM sells its inventory at 28.25). The MM pockets the difference (1.63). Illiquid stocks aren't very profitable for MMs, because their income depends somewhat on trading activity. Wide spreads allow the MMs to make more money per trade, and this is supposed to compensate for the lack of activity. But anyone who understands supply and demand realizes that wide spreads discourage trading, so it's not a very effective system. In other words, it's a positive feedback system (amplification), rather than a negative feedback system that is self-correcting. An extreme example of this amplification is the OTC:BB stocks, which tend to have huge spreads, and low trading volume. Because of the large spreads, people don't trade it much, and because they don't trade much, the spreads get wider. It should work the other way, but the MMs' desire for income creates a vicious cycle. The key is that most illiquid stocks with huge spreads have few MMs, if not only one. As a result of the monopoly that such an MM has over trading in a stock, the spread can be as wide as it wants. I don't know how many MMs LUFK has, but I bet it's fewer than 5. As more MMs trade a stock, the spreads tend to shrink, due to competing bids and asks. Your question wasn't naive at all. The naive investor doesn't even consider the bid and ask, and he is the MM's favorite customer. Wouldn't you love to pocket the spread on a stock bid at 20 and ask at 30? That's why it's crucial to set limit orders, usually between the ask and bid. Todd