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.
