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[morchel]

Market Maker Speaks Out:Ways of a Market Maker



I was an 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 what`s known 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 that MM who performed (his life blood). This will go on until he "fails" to perform and so on.

Contrary to popular opinion the "Big" firms Do NOT neccessarily go to the "Low Offer" to fill a buy order (Or high bid for a sell). They "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 wholesaler 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.

With the above groundwork laid, 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 quietly 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 fills 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 lose 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 all right 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 spread" 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 the 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 particularly 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."


morchel

[Orgasmus]

So, so!

[Teffie]

kann das auch wer ins deutsche übersetzen

DANKE!!

[red.x2]

Aus dem RB-Board:

Heres #1 ,as for #2 I haven`t seen that one....
I find this very interesting....
1) By the very nature of the business, Market Makers are short on most, if not nearly, all stocks on the OTCBB.

--- Ever wonder what happens when a stock that has an average trading volume of 10,000 shares gets hot and trades 1M shares in a day? The MMs don`t have that kind of stock in inventory. They just keep filling the orders. The MMs are there to service the retail brokerage industry. The customer at a full service brokerage house does not want to hear, "we can`t find the stock for you to buy." No way! The MMs fill ALL orders to keep their big retail brokerage houses happy, because they in turn have to keep you happy. (The world is surrounded with all this fuzzy happiness!) ---- So what happens? --- The MMs keep filling orders, regardless of how "negative" they must go in their own accounts. Do they care? Not really, and there are several reasons for this. The bottom line is this, no matter how bad it gets, they can always "borrow" the stock from the DTC (Depository Trust Company) Who and what is the DTC?

---"the DTC is a brokerage clearing firm and transfer center. We`re a private bank for securities. They handle the book entry transactions for all banks and brokers. Every bank and brokerage firm must secure their membership with them in case they become insolvent, so your assets are secure with DTC". Yes, you read that correctly. The DTC is a private bank that processes every stock and bond (paper securities) for all U.S. banks and brokerage houses. As of April 19, 1999, the DTC itself has stated that their assets total "nearly $19 trillion."

In other words, these guys are to the brokerage industry as what the Federal Reserve is to the banking sector. If a bank needs money they borrow it from the Fed, if an MM needs stock he does not have he can balance his account, with a "loan" from the DTC.

Are the MMs worried about not be able to borrow the stock from the DTC? NO! Why? Look at this statistic ---"the Depository Trust Company absolutely controls every paper asset transaction in the United States as well as the majority of overseas transactions, and they now physically hold (as of April 1999) 99% of all stock and bond book-entries in street name, not the actual owner`s names.

The MMs KNOW they can get stock anytime. How much can the MMS borrow? AHH!!!!!! Here is secret ---They can only borrow as much stock is in the float. In other words, the MMs only need to know how much stock is in the float, and then they can "short" the entire amount. If EVTN has 1.4M in the float, the MMs can borrow 1.4M and the stock will trade as if there is 2.8M shares. The MMs have the ability to double the float.

So let`s play make believe. Let us say that EVTN gets back on the OTCBB and puts out some great news. The stock gets hot. And let`s assume the MMs short the entire float. What happens next? --- DOUBLE PRINTS on the transaction log! They only fill orders after they buy it from a willing seller with a standing limit order, a new seller enters the market, or they borrow it from another market maker who might have a little "room" left in their account. We have noticed that some people lately have been putting in market orders that sometime take hours to fill. It has happened on several occasions to someone in our group. There are other reasons to cause this too, i.e. illiquidity on the pinks, no orderly market, etc.

(Sorry I couldn`t make this short, Multi) Now what? Well EVTN`s stock will go up on its own merits even if the MMs are heavily short. If the company is as real as we believe, it will rocket. But can we maybe help it along a little? hmmmm...

Imagine this, the MMs after they are heavily short suddenly find out from the DTC that the amount of EVTN stock they can "borrow" this month is less than they had borrowed last month and now they need to "cover" the difference. All the garbage you read on the threads about a "short squeeze" is mostly a bunch of BS, you can`t squeeze the MMs enough, but on a small float stock ---OH YES YOU CAN!

How would this happen? Well, let`s say that enough of the longs decide to call in their certificates and take possession of them. Now instead of 1.4M in the float, there is only 1.2M in the float ---what happens? Remember the MMs have the "effective" float at 2.8M (2 X 1.4M), but now they can only short 1.2M, or in other words make the effective float 2.4M. YES!!! EVERY SHARE THAT YOU CALL IN FORCES THEM TO BUY 2 SHARES!!! Only 200,000 shares were taken in certificate form, but the MMs must now cover 400,000 shares! ---Imagine Multi, the MMs finding out that they need to buy 400,000 shares in the open market! What happens to EVTN`s stock price?

Personally, my wish would be for every long term shareholder to call in at least 50% of there EVTN stock in certificate form.

Multi, I have been informed that a supervisor at Ameritrade did make a statement that you can prohibit your stock from being borrowed by putting in a GTC sell order above the current market price. Is this true? I don`t know. I also heard that stock in CASH accounts cannot be borrowed, either. My suspicion is that this latter statement in false. The only ABSOLUTELY GUARANTEED method is to call in your stock!

So what does this accomplish?

1) A faster rising share price
2) Hopefully less volatility

but much more importantly....
3) The ability for EVTN to move off the OTCBB because of its increase value of the float ( a major listing requirement)
4) Force the company into making stock splits much sooner to increase liquidity

Sorry for the length and I hope this helps a little. Like I said in the opening, to all readers, this is my opinion which is based on many assumptions, and thus speculation on my part.

How often does the the DTC notify MMs? I don`t know this answer. I have been told monthly, three trading days before each month`s end. Is this true? I don`t know.

If anyone has more concrete information please post it. This is a topic I have long found interesting