Is this correct about market makers?

Discussion in 'Trading' started by xBoba, Sep 22, 2012.

  1. xBoba


    How a market maker works

    Basically, i understand the purpose of having a market maker is to faciliate a trade. For example, if I want to sell 1000 shares of Disney at $100, there won't always be a buyer on the other side willing to buy it at the exact number of shares and the exact price. This is where market makers come in. They are willing to risk buying my 1000 shares of disney stocks at $100. But they have to be compensated for the risk in holding the 1000 shares of Disney stocks (the stock could go down after MM buys it). The MM is compensated for it by selling the 1000 shares at a price higher than $100, and making money off the spread. For example, after selling it to MM for $100, the MM may set an asking price of $105 for 1000 shares. If someone else buys the stock, the MM makes money off the spread of $5/share. Is the MM's desire to be compensated (by making money off spreads) for the risk he's taking in holding the 1000 shares of Disney stocks one of the reasons markets have an uptrend? Because no MM is stupid enough to sell the 1000 shares at $99, which would cause him to lose $1/share. So since his asking price is always going to be above the price he bought the shares at, as long as someone buys his shares, the price will go up.

    The way MM leads the direction of a particular stock is that when he has a high % of shares of a particular stock oustanding, traders basically have to adhere to this MM's rules. If the MM wants a particular stock to go up, he will set a higher asking price, and if he wants it to go down, he will set a lower bidding price to buy the stock.
  2. iggy9807


    I am no expert and I don't know the exact rules market makers have to adhere (like how often they have to provide inside quotes) but I do know that market makers are not in the business of trading the underlying so they would not own a big % of any given stock. That would expose them to too much risk. Instead they move their bid/offer quotes depending on how much stock (long or short) they have. Here is an example:

    At last the close, UBSS had an inside bid but not an inside offer suggesting that they might have low inventory or a (small) short exposure to TIXC.

    I can't imagine why and how market makers would influence the direction of a stock. Other than if the stock makes a big up move and they would sell all their inventory. Then, if they must provide an inside offer and they don't want short exposure, they would have to buy some shares first. That seems like a stretch though. Again, I would be curious to know what % of the time market makers are required to post an inside bid/offer. It's quite possible that there is no such requirement.
  3. iggy9807


  4. xBoba


  5. No.

    You are assuming that all market makers are highly informed, skilled and never lose money. That is not true. Even those who are very skilled may lose money, in particular when trading with informed traders who actually move price towards fundamental values.

    Facing an adverse movement, a market maker may find himself carrying a large inventory that he may have to liquidate with a loss, unless he`s able to hedge in another market. And that is one of the reason many market makers avoid carrying too large of an inventory, because of the risk associated with carrying it.

    I don`t think the MM leads the direction of a particular stock, at least not in a liquid market, although he will influence his clients to buy or sell by for his own benefit by adjusting his quotes.
  6. xBoba


    Thanks for the reply.

    I'm constantly hearing about the "big players on the block" and "market makers." For example, in the Elliott Wave, the initial uptrend are the "big players" buying in on the stock. Then goes a small correction. Then the wiser traders jump in on the bandwagon for the 2nd uptrend, etc...

    What I want to know is: Who are the "big players" that are buying in the 1st elliott wave if not the MMs?
  7. You should read the book Iggy linked to. It will answer a lot of your questions.

    Market makers are making a market and offering liquidity, although some will speculate as well. But they don`t create trends per se.

    Those who move the markets are other kind of traders, like institutions or the aggregated effect of multiple players in a trend.