Someone sent me this, interesting reading
Anyone who frequents stock chat-sites has seen a great number of posts
about the dreaded MM's - the Market Makers - who seem to be the
illegitimate children of Darth Vader and whose mission in life seems
to be thwarting the money-making masses in their quest. The truth is
not nearly as interesting, and we felt that a short background on how
and why the MM's do what they do would be in order.
The "unlisted" market - which is a misnomer, for sure - is tiered into
(1) the NASDAQ, comprising a couple of thousand of the largest OTC
stocks, subject to a number of requirements on net worth, reporting
status and price, and traded with real-time, firm quotes and generally
small spreads, (2) the OTCBB (Bulletin Board) stocks, greater in
number, smaller in size, traded with "subject" quotes and without
reporting requirements, and (3) the "Pink Sheets" - from the color of
the paper this list has been printed on since age immemorial - the
smallest stocks, for which no NASDAQ member filed a BB registration
form, a list that comprises a lot of semi-private companies, semi-dead
companies, semi-smelly companies and a whole bunch of shells (picture
a huge, pink swamp...).
Unlike the large exchanges that use "specialists", the OTC market uses
Market Makers, investment firms with varying degrees of brokerage
operations and a group of OTC traders who try to make money trading
stocks that they choose to specialize in (and have in inventory in
varying amounts). Picture a boiler- room full of crazed 29 year-olds -
of every other human stripe - high on caffeine, funny, banging loudly
on their phones,plus couple of grizzled veterans who are their
ring-masters. What are their goals ?
1. ORDERLY MARKETS. Yes this is their secondary goal. Their primary
goal is making money for the firm. They will inventory stocks that
they have a good feel for, that are relatively liquid, on which they
will not be caught with their pants down. Thus, the spread of a stock,
reflecting the bids and offers of all the MM's of that stock, will be
a picture of the size of traffic, of quality of information, of "buzz"
(rising and falling, especially now with the proliferation of
"pump'n'dump" and know-nothing chat-boards) and, most importantly,
inventory levels. When a spread expands, the MM's are running low on
inventory and they don't want to get caught in a squeeze (short or
long) if Charley Schwab showed up wanting to buy 100,000 shares. Which
brings us to #2.
2. FILL ORDERS. A market maker wants brokerage firms to do business
with them and to come back to them again and again. This means that
they will often buy or sell much more stock than they have, leaving
them with a net long or short position temporarily. In an orderly
market, the MM's can use the spread to his advantage and "square" his
position. The exception is when the stock is a fast mover and they end
up over-extended and at great financial risk. This is when
#3 comes in.
3. WALKING A STOCK. Market Makers are a club, who look out for each
other, even as they compete with each other. They know very quickly
when one of their ilk is caught with a major imbalance. Through the
subtle signal of spreads,sizes and through negotiated telephone buys
and sells with the firm in question, stocks are allowed to move up and
down to a level where the troubled MM can square his position and his
brethren can take advantage - but no too much ! - of his
miscalculation. This happens all the time, and imbalances can last for
days. Active penny-stock traders complain when a fast-riser is being
held down or "walked down", but these MM's are the same people who put
the stock to them - from long inventories or a willingness to short -
when they were looking for size to buy. So, go a little easier on
them, they're not the enemy - it's OK to feed the animals in the zoo...
A few good ways to avoid being on the receiving end of the MM's
strategies:
(1) do not chase stocks, you might be the last guy holding the bag,
(2) make sure you know what you are buying or selling, i.e. get real
info, not "tips" and "hype", (3) avoid stocks with big spreads, the
information may be bad or bogus and (4) do not short micro-caps,
because stocks with small floats can move like lightning either way.
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