October 28, 2011 at 9:40 am | | Comments 5

Market Makers, Specialists, and Stops

A subscriber recently asked me:

“Do you believe market makers and specialists really gun for the orders that are on the books that are only a few hundred shares, or do they only search out bigger size?”

Here’s my response:

My take on market makers and specialists is that they just want volume, all day, as they’re selling on the offer and buying on the bid.  A few hundred shares here throughout the day add up to a lot. Stocks will naturally gravitate toward key areas of support and resistance, so if they just get close then it’s not that difficult for market makers to ‘spook’ prices a little further and run some stops.

Suppose there’s resistance just a few cents away, they know buy stops reside beyond that level. Flashing a big bid will have shorts quickly covering based upon the quote (which is real by the way), and buyers step in front of it in hopes of catching a run. They can then flip that large order to the ask and it spooks everyone to sell, taking the stock right back down to where it was.

You can see how doing that throughout the day adds to the back-and-forth range-bound type of price action which churns the accounts of retail traders and leaves the stock not necessarily making any big headway.

Also, do not discount the presence of programs doing this exact same thing.  If supercomputers can automate the process via algo’s, all the better for the smart money to spook the retail traders out of positions on a regular basis.  Head-fake moves which last only long enough to inflict enough pain to prompt an exit is all it takes, so it need not be a lasting move to catch the small trader off guard and separate him from a dime here or a quarter there.

One last thing…

On a trend day when market makers are shorting into strength (selling on the offer during an uptrend ), if they didn’t have a lot of inventory to dump, then they’re getting shorter the higher we go. They will hedge via futures (ES or NQ) or through options. Those derivatives have a huge impact on how the market moves, yet few traders really recognize that.

So when people watch call buying activity or put buying activity in the options, they think they know that someone big is betting on a rise or fall in the shares, but the fact is nobody knows if it’s that simple or if it’s part of a more complicated hedge for a market-neutral position.

It gets cloudy, but there’s my take on market makers and specialists.  What’s your opinion?

Trade Like a Bandit!

Jeff White
Producer of The Bandit Broadcast

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  1. Jeff, that is a very useful analysis of an always grey area. Thanks for your thoughtful contributions to our understandings of “the market”.

  2. I bought DPM.TO up here in Canada yesterday. It gapped down at opening this morning hugely and triggered my trailing stop and immediately shot up after that and carried on going up. I’ve been trying to figure out what the market makers were up to, and if the opening can be predicted at all. I’m scared of the opening now, but can’t day trade as my day job is too hectic. Do you have any thoughts?

  3. You bet Bill, thanks for stopping by!

  4. Hey Mark, some brokers allow conditional orders which can be activated after a designated time (ie: 9:45am ET). You might look into that. Otherwise, perhaps using a smartphone app after the open to send in orders you’ve predetermined.

    Not sure if either is an option for you, but my broker offers both.

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  1. From Market Makers, Specialists, and Stops ( | Finance on Oct 30, 2011

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