Traack Technologies Inc (TRAA)

[falon]

THE MARKET MAKER EFFECT


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To move deeper into tape reading, we have to understand how to view key players at specific price levels. This is a necessity of trading slower momentum stocks because we are not relying on fast momentum to offer us profits. Instead, we are relying on information about perceived intentions of what Market Makers are doing.Understand that Market Makers and institutional traders are not going to be too hip on showing us their intentions. Otherwise, their intentions would never be fulfilled because traders could potentially ruin their plans for orderly distribution or accumulation. These traders, when accumulating or distributing orders for themselves or their clients, want the stock to move orderly so that they are not paying too much for the stock, nor selling at prices that are too low.

If they flashed intentions to buy 1 million shares of stock and traders knew this, then people would be buying like crazy at this point in anticipation that this 1-million buy order would push the price up as well. This would make the institutional trader have to buy one million shares at a higher dollar cost average. On 1 million shares, this can cut into profits in a big way. Therefore, they are very concerned to mask their intentions and for the most part, we dont know the exact intention. Even if we see a few things happening that suggest a Market Maker is a net buyer or seller, we never know how much of the order he still has to fill or if hes already done. Therefore, we have to watch for a combination of basic tape-reading principles according to the idea of accumulation and distribution in conjunction with what a specific Market Maker may or may not be doing.

Previously, I discussed a Market Maker or institutional trader that was willing to facilitate an order for clients by becoming support or resistance at key price levels. I noted the example of the upgrade in which a Market Maker would sit on the Ask, sell shares out of his own inventory to retail traders, and then transfer the clients order to the Market Maker inventory to cover those shares sold. In this scenario, everybody wins. Let me explain why. If you are a fund manager that wants to sell 200,000 shares of XYZ stock, you dont want to go on the open market to buy at uncertain prices. Nor do you want to display your intention to buy this much in stock to other traders. Otherwise, they may see this order and try to get in the stock as well. This pushes up the price of the stock, and you will pay more for the stock by not hiding the true intention in some manner. Many use INCA in this case to facilitate large orders, but for the purposes of tape reading, the following information is useful.

You want to sell 200,000 shares of stock and feel that if you use INCA or some other trading service to mask this intention, you may not get the price you want. Therefore, you will call your favorite Market Maker to facilitate this order for you. What he will do is agree with you on the price or prices at which to transact this order for 200,000 shares.

To make this explanation simple, lets suppose that the stock is trading at 40 on the Bid price by 40.05 on the Ask price. Your quote screen would show 40 40.05. The Market Maker feels he can reasonably facilitate your order for 200,000 at 40. If this price is agreed upon, the Market Maker will now attempt to sell 200,000 shares at 40.05. This would identify the Market Maker to those that are able to see this on the Level 2 screen as the ax of the stock.

This is because the Market Maker is not letting the stock trade higher than 40.05 before he fills his order of 200,000 shares. The reason he wants to sell 200,000 shares at 40.05 is because he will be buying your sell order for 200,000 shares at 40. If he buys 200,000 at 40 and sells that same amount at 40.05, then he stands to profit a gain of $10,000 (200,000 x .05) for his trouble and risk involved in facilitating the order for you at 40. If he sits on the Ask at 40.05 and absorbs all the buying, once he gets to 200,000 shares, he will then transfer the block from your sell order to his account. Covering the 200,000 he just sold and a block of 200,000 shares will cross the tape or possibly in some other combinations, such as four blocks of 50,000 each, all at the price of 40. Normally, the transferred blocks will be at the inside Bid price or sometimes lower.

Once a trader identifies the Market Maker as the ax and then sees these blocks move across the tape, that trader would expect them to lift off the Ask and for the stock to move higher. This makes sense because the Market Maker is not a true seller of the stock, meaning he doesnt want it to go lower, and that the stock should rise as soon as he lifts off the inside Ask if he is the only real seller at the price level of 40.0625. He was not a real seller and was simply facilitating an order for his client that was beneficial to him because he sold his stock at 40. If the stock moved to 39.50 during this facilitation, he wouldnt have cared. They both agreed on 40 as the price. Because the Market Maker agreed on 40, his risk is that his absorbing the buying would create nervousness and the stock would fall. If the stock had fallen below 40, then he would be selling stock at a lower price than he bought it from the client. In this case, the Market Maker loses money on the trade, assuming the majority of the shares sold is under 40.

This is the risk Market Makers take and the reason that they are compensated for their trouble by profiting from the spread. Many wonder why the Market Maker would accept such a risk. The reason is that the commissions and fees derived from these numerous orders from big clients result in a lot of trading profits over time. The institutional traders and fund managers will enjoy the collaboration in that they know they can rely on the Market Maker to facilitate their order at better prices than they feel they can obtain, and the Market Maker profits by continuing to make the spread on these orders. It is a partnership of sorts in which both gain in the transaction. As for tape reading, this is why we want to identify the ax of a stock in such a case.

Remember that if a stock is slow-momentum and under accumulation, we will want to figure out whom the net buyer of the stock is that is accumulating and also any ax of the stock that may be hindering the climb. If we enter into a position on a slow stock and can identify the ax and the net seller, if there is any action in either of these two participants that would negatively affect the price against me, I would be more inclined to exit the position with surest profits. If one or both of these participants continue to raise their Bids and offers in an orderly manner, then the continued accumulation may not be over, and I may want to hold longer. Either way, this type of tape reading is a very beneficial way to gauge the direction of a slow-momentum stock and provide more viable trades to your trading plan.

The basic setup in a slower stock is to: watch for the ax at the inside Ask price to be identified by absorbing the buying, then look for blocks to cross the tape at or below the inside Bid price, and then watch for the ax to lift off the Ask. If this happens, you may elect to hold the stock if you are in from lower levels or you can enter into the stock for a quick scalp-type move.

The opposite case is true for a Market Maker that has been identified as providing support in a stock. Suppose you, as a fund manager, come to me, the Market Maker, and want to buy 10,000 shares of stock. I will facilitate this order for you at 40.05, and you agree to this price. I will then go on the Bid at 40 and buy 10,000 shares worth at 40 from retail traders. Once the 10,000 shares are bought, I will then sell you my 10,000 shares at 40.05, basically transferring your buy order to my account and profiting $500 (10,000 .05) for my trouble. Once I transfer your order to my account, you will see a block of 10,000 across the tape at the Ask price and for me to drop off the best Bid. If a trader is short the stock in this case, he will be glad to see that I am not a true buyer of the stock (providing support) and when I drop off the Bid, this might provide more downside potential.

The most common question is why doesnt the ax just lift his price and sell at higher levels. This is quite a simple answer if we understand the reasons of why the ax is really the ax. The ax is not a Market Maker that wants the price lower so he can buy at cheaper levels. This is often a very wrong comment that is made in many chat rooms. Obviously, if the Market Maker wants to accumulate shares, the lower average price, the better, but for purposes of tape reading, the answer is easier to explain. If I agree to buy your shares at 40 and I believe that I will not have any trouble filling this order at 40.05 for 200,000 shares, I will stay right here to assure myself that I fill the whole order and not risk the stock moving lower, creating a loss.

If I move up a level higher, I will be competing with other market participants at those prices to sell, and in this case, I may not be able to fill the whole 200,000-stock order. My initial purpose is to facilitate the order in a fast, beneficial, and relatively certain manner. The purpose isnt to get greedy and see how many more .15s I can squeeze out of the order for my own benefit. Obviously, if I can I will, but if higher price levels look like too much competition to fill the order, I will stay where I can assure myself I can fill the whole order. This action identifies a key player or ax in this scenario. This is only something a trader can view by watching a Level 2 screen relative to the Time of Sales information that comes across the tape.

Again, tape reading isnt just watching prices going across the ticker. One has to understand who is doing the buying and selling and for what purpose. On the macro view, institutions are usually buying low and selling to retail traders and vice versa. They are selling at the highs when the markets are showing signs of a panic buying and then accumulating shares on panic selling. On the micro view, we are looking for pace and price action relative to increases and decreases in volume and price direction. We are also looking for block trades to cross the tape and identify who the supporting Market Makers are or who the identified ax is. We are trying to figure out what those blocks mean and how can we either profit more by doing so or taking surest profits if what we believe is a negative on specific price action.

Tape reading goes far deeper in understanding than just reading the ticker tape buys and sells ratio. Learning to read the tape in relation to the previous information provided will give you a much better sense of why markets and stocks move and how to best profit from this understanding.