I read this the other day and it makes sense and gave me a little more insite on MMs... enjoy
Published on July 25th by anonymous author, we cannot vouch for the validity of its contents:
The King Explains the MM Pricing Game 25-Jul-08 12:53 am
With BBs, it is very easy for a MM to get trapped into being short. Reason being; most of the MM’s in this stock are what are called “wholesalers” - they don’t have retail brokers “working” the stock.
They rely on the “call” from larger retail houses. If a “Big” retail firm (E-trade) calls up a MM to buy 5,000 shares, they expect an “execution” from that MM. If he turns them down, or a partial fill, then the “Big” firm will go to another MM.
If this second MM “fills the order” then that “Big” firm has a moral obligation to continue to give future “business” in that stock to that MM. This goes on until he “fails” to perform.
Contrary to popular opinion the “Big” firms Do NOT necessarily go to the “Low Offer” to fill a buy order (Or high bid for a sell). They “Go” to who they think will perform to fill the order and expect that MM to “match” the “low offer” in the case of a buy (bid in the case of a sell). Even though this MM might in fact be the “high bid” and not really want to sell any more.
As a wholesaler he must perform or he will get a reputation as a “non-performer” with the “Big” houses and will cease getting “calls” which means he will soon go out of business.
How MMs get short even if they like the Company; Lets say that a stock (shell) has been lying quietly at $.25 bid $.50 offered. A limit order comes into one of the MM’s to Buy at $.50 for 1k sh. Prior to this trade that MM may be “flat” (neither long or short any sh). He fills the order and is now short 1k sh. He may raise his bid hoping to find a seller to “flatten” out his position. But before he realizes it a wave of buyers have come in and cleared out all the $.50 offers. Now the stock is $.50 bid .75 offered. Here comes that “Big” firm he just sold the 1k sh to at .50 with another bid for 1k @ .75. He makes this print. Now he is short 2k at an avg of .625. The market keeps moving and now its .75 bid 1.00 offered. Now he has to make a decision.
MM Hate to take a loss. So 9 times out of 10 he will now sell 2k at 1.00 making him short 4k but with an average .81. At this time he would love to see a seller at .75 so he can cover his short and make a few bucks.
But instead the market keeps moving up. Now it is 1.00 to 1.25 and here comes the buyer again at 1.25. He doesn’t want to lose the call so now he needs to sell 4k at 1.25 to keep his break even point above the bid. Now he is short 8k. Market moves up to 1.25 bid 1.50 offer here comes the buyer now he feels he must sell 8000 here because “stocks don’t go up forever”.
Now he is short 16k. And so on and so on. If the stock keeps moving up, before he realizes it he could be short 50k or 100k shares (depending how big his bank is).
Finally the market closes for the day and on paper he may look all right in that his “break even” price may be around the closing price. But now he has to figure out how to entice sellers so he can cover this short. It is important to note that if this happened to one MM it has probably happened to most all of them.
Some ways MM’s entice sellers; Run the stock up with a “tight spread” in a fast market, then “open” up the spread to slow down the buying. After “cooling off”, they lower the offer below the last trade right after a small piece trades on the offer then tighten the spread so that the sellers feel they can take a “quick profit” by “hitting the bid” on the tight spread.
Once the selling starts the MM’s walk it down quickly by only making small prints with a tight spread. Or, by running the stock up in the morning, averaging up their short then use the above technique to walk it down in the afternoon.
This post was submitted by MMInfo.