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."
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Credit for this post goes to Cardshark_1999
