This is a theory put forth by a lot of penny
stock traders. This is not a guaranteed trading
method but can lend some insight to communications.
We've worked on OTC (NASDAQ) desks and worked
with many actual market makers. We've never
worked with the smallest of penny stock market
makers, those trading shares below $0.10, but
we can attest that many market makers will use
certain signals that can be helpful - especially
helpful for those of us trading small stocks,
but not ones like the example above, the tiny
stocks.
When a market maker is at the bid or offer showing
100 shares for sell or purchase, in a majority
of the cases, he or she does not have 100 shares
(only) for sale. Market makers are in the game
to make money for themselves as well, while
still executing orders for clients.
They will almost never show their hand to let
others know what order they are working. For
instance, let's say a market maker has an order,
or know he will be getting an order to purchase
2,000 shares of a stock at $5.00. He will never
bid for the full 2,000 shares. he will place
a 100 or 200 share bid at $5.00. Why? Simple.
What if there is someone, possibly another market
maker hoping to sell 2,000 (or more) shares.
If the market maker places all 2,000 shares
at the bid at $5.00, the seller can them immediately
put the shares to him and the trade is over,
all 2,000 shares at $5.00.
The market maker with the bid will put up only
100-200 shares to see if any fish bite. If they
do, he'll remember who sold him those shares
and move his bid down to $4.95 or so and see
if he can get more there. If he does, great,
he'll keep working the price down as far as
he can go to get the shares as cheaply as possible.
Perhaps he now has 2,000 shares with an average
price of $4.90. When his customer comes along
with the order to buy the 2,000 shares at up
to $5.00, he can then sell them to his customer
at $4.95, or $5.00 for that matter. At $4.95,
the customer is happy because he would have
paid up to $5.00 per share and the market maker
is happy because he made $0.05 on each share.
If the market maker put up a bid for the full
2,000 shares, that would cause many market makers
to lift their price higher. Why not? They see
that somebody out there has a decent order and
they want to sell at the highest price possible.
That's why many marker makers will never post
more than 100-200 share bids or offers unless
they have a very large order.
Even if the market maker would buy all 2,000
shares at $5.00. Perhaps he's busy and doesn't
care to "work" the order for a better
price, he'll still put only 100 to 200 shares
on the bid. If someone offers him 2,000, he
can accept that (he's only on the hook for the
100 or 200 he had listed) and close the trade
if he wants.
Instances like this happen all of the time for
many thousands of shares. Market makers try
their best to make money like that, but it doesn't
always work. If that market maker places too
many shares at the bid, others will think he
has a large order and they will move their sale
(offer) price higher. In that case, either the
buyer has to pay up, or the order won't go through
and that market maker has no chance at making
any cash, and his company has no chance at charging
a commission.
If you do see a "real" market maker
posting a large position, say 500 shares or
more, there's usually plenty of more shares
behind that. What we mean by a "real"
market maker is an actual NASDAQ mm. In many
cases, folks who place online orders through
an online discount broker will place an order
to buy or sell 500 shares or more. These will
show with the firm's name, say "NITE"
or "ISLD", who usually deal in online
orders direct from clients. The market makers
know this, so an order from ISLD at 500 shares
will not move the market like an order showing
for 500 shares from "RAJA" or Raymond
James, if they make a market in that stock.
It can be fun to watch Level II quotes. If your
broker makes them available for you, use them
to watch the market makers and see what they
are trying to do. Sometimes, you can guess right
on what is happening.
For another quick example, let's say that a
company you are looking to buy has announced
that they are repurchasing their own stock -
and a lot of it. They'll use a brokerage firm,
of course. Watching the Level II quotes may
let you know who might have the order and what
they are willing to pay. Let's say Raymond James
(RAJA) has been bidding all week for shares
at $1.00, and almost never moved. They've been
buying at that level all week. The next week,
RAJA is nowhere to be found, but another broker
is now bidding the same way. You can almost
bank on it that the company is willing to pay
at least $1.00 for their shares and will soak
up almost any number of shares to keep the price
there. They are also spreading around the order
to several brokers to keep them happy. In 99%
of the time, they will be brokers who research
that company's stock. The only way researchers
get paid and make any money doing the research
is by getting orders. Company's will almost
always send these orders to the firms that research
them as a 'thank you' for the research (as long
as it's positive). Buying those shares, if you
already like that company, at $1.00 would make
a nice bet as the company looks like they are
willing to do what it takes to place a floor
at $1.00 and keep that stock there or above.
How can you be sure it's the company's order?
Here's a VERY important tip: When a company
is buying their own shares back, they cannot
be the first trade, and cannot trade in the
last half-hour of the day. So, if we do see
RAJA or others bidding for shares and that bid
disappears at 3:30 ET, a half-hour before the
market closes, you've found the company's broker
- at least for that day or week.
