Market Makers – Who Are They And What Do They Do?

What Is A Market Maker?

The Market Maker works for an institution that makes a market (will buy and sell) that particular stock. They provide the market with liquidity.

Market Maker = “someone” who is always quoting a bid-ask spread for a given stock/contract.  Usually, the market maker profits from the spread between the bid and the offer or the manipulation of a price. The more actively a share is traded the more money a Market Maker makes.

Level 2

A good Level 2 will give you an indication which Market Makers are priced. Your broker using the same systems as you now have can sometimes get a better price than those on the screen. This is because Market Makers compete with one another for business.

When your broker calls the Market Maker he is giving them the opportunity to ‘bid’ for the business, the Market Maker may well improve on the price on offer via the screens. The Market Maker only makes money when they are buying and selling, so the Market Maker will prefer to see the business go through their books at a reduce margin than allow it to go to another Market Maker.

Role Of Market Makers

When you buy and sell shares in most circumstances, your broker has to go through a Market Maker. The Market Maker works for an institution that makes a market (will buy and sell) that particular stock. They provide the market with liquidity – i.e. there will always be a price you can sell your stock at, there will always be a price you can buy some stock at (unless the share is halted).

Market Makers are however known to lower prices to “panic” investors into selling, sometimes called “shaking the tree”? Moving the price up, encourages sells, moving it down also encourage sell, hence also the term dead cat bounce when a Market Maker will mark a falling stock up to encourage buyers in thinking they have reached the bottom.

If a Market Maker does not want to trade in the stock he is making a market in he may make his bid/ask spread so wide to discourage anyone to trade with him. If all the Market Makers do this the stock can become illiquid temporarily as no trades are going through – buyers do not want to buy, sellers do not want to sell their stock at what they envisage is a poor bid price.

How Do You Trade Against A Market Maker?

How To Look For Market Maker Moves?

Watch the Time and Sales and the Level 2 – You will start to see areas where there is accumulation or selling.  Those usually correspond with levels on the chart. 

Soaking up size – Soaking up size is when a market maker buys or sells more shares of the stock than they show on the level 2 screen. If a market maker is soaking up size on the ask, there’s a good chance it’s dilution and this is a bearish sign. If a market maker is soaking up size on the bid, that means they could be accumulating shares or creating a level of support, which can be a bullish sign.

Fake Big Orders – One of the best ways to mess with the psychology of the market is to show big orders on a level 2 screen. Big orders on the bid make it seem like there is a large demand for the stock, while big orders on the ask make it seem like there is a lot of supply. These levels can act as mental support and resistance levels for traders using level 2 screens. Market makers know this and can place big orders to move the stock in a certain direction. For example, if I buy 100,000 shares of a stock at .03, and it runs to .04 where there is a market maker showing 5 million shares for sale, I (along with other traders) may sell the stock. The large order may not even get filled at all, however, its presence alone has an effect.

Pay attention to the order flow of market makers with big volume. The massive electronic wholesalers are notorious for order flow arrangements with retail broker-dealers. They often take the other side of trades so it’s prudent to spot when they are too committed to one side or the other.

Be conscious of misdirection whether from traders or market makers. Be aware of late prints as well as hidden and iceberg orders on time and sales. When you see just 100 shares offered on the inside ask but time and sales prints over 10,000 shares executed at that price, it tells you there is a heavy hidden seller. The faster you spot this, the quicker you can avoid or trade the fade as participants panic out.

Shorting – Many people make the assumption that market makers want to see a stock rise in price. Keep in mind that market makers can short sell a stock and profit on the way down.