Stock Market Workings

Q. When you see a trade go through for say 12 shares or even 1 share, what is that all about?

Surely it can't be a personal investor, is it some sort of balancing act?

A: Say there are 1,100 shares available to buy on the order book. Someone buys 1,080 leaving 20 shares there on the book. The next buyer may buy 2,000 shares but the 20 shares left on the book go through as a separate buy even though the buy was for much more. In the US you actually see these separate buys on your contract note so a purchase of 200 DELL might show as 2 80s and a 40 making up the 200 that you have bought.

Also, not a lot of people know this and there is a reason why, its pretty useless information but...Crest, Bloomberg, UBS, RBS, etc. anyway, most brokers, clearers, settlement banks, data people, all buy 1 share in almost every listed company so that they automatically receive and are entitled to any corporate information. It may not be the reason for any specific purchase or sale but its one of the reasons a buy/sell of 1 share.

Q. What does it mean when a market maker's price for a share is £1.69 sell and £1.75 buy (6p spread)- does it say you are not buying any but you can sell them?

A: It simply means you can buy from the market maker at 1.75 and sell back to him for 1.69. The spread is what the market maker gets for doing the transaction. He will widen the spread or narrow the spread to suit his purpose. Narrow spreads tend to attract buyers because they can make money faster and wider spreads attract sellers because sellers know that buyers won't buy a big spread.

Q. What are these big trades I'm seeing being traded off the market (not showing on Level 2)?

A: Being traded off the market means that single sellers may be placing big amounts directly to funds so you will only see them when they disclose it. However, you cannot see or know when they do this (only if you have an interest in the instrument but that means that you will have to place a bid or offer and we are always talking about big amounts here).

Q. 6x more buys than sells and yet the price has fallen...

A: I never take much notice of supposed buy/sell ratios. The very biggest trades (the ones most likely to be influencing the price) are the ones most likely to be (legitimately) recorded hours later - or even a day or two later, and therefore missing. I tend to regard the price itself as a better indicator than the live buy/sell data.

Q. What are these big trades I'm seeing being traded off the market (not showing on Level 2)?

A: Being traded off the market means that single sellers may be placing big amounts directly to funds so you will only see them when they disclose it. However, you cannot see or know when they do this (only if you have an interest in the instrument but that means that you will have to place a bid or offer and we are always talking about big amounts here).

Q. What is extended settlement?

A: Normal share purchases (in the UK) settle in 3 days (rolling). This can usually be extended to 10 days and even longer (hence t10s, t20s..etc). However handle with due care, the more the settlement date is extended the more you have to pay and it might be eventually cheaper to borrow the monies from your bank...

Q. When news comes out how does the stockmarket know what price to set each stock if there's a change in interest rates for example?

Does someone input data into the stockmarket system or is it all down to what price a market maker wants to set? Do they have the freedom to set any price then? Don't laugh! but how does the stockmarket conclude that my Royal Bank of Scotland shares are only worth 50p? Who is the swine setting this price? Not that I'm about to go and find them :)

A: Quite simply traders and market makers set the price. If something happens unexpectedly traders will input higher or lower prices directly onto the order book and it's a matter of when buyers and sellers start to trade around the same price then the price settles. So really it is whole combination of people punching in prices rather than one guy deciding it!

Otherwise, it's mainly about the USA. If the Dow Jones ends well down from the time the FTSE 100 closes then big boys bash it out in pre market auctions which determine the opening price. The performance of the Dow and S and P are what really affect prices which is why there tends to be bigger price swings after the Dow has opened. At some point if you get level 2 you can see it all happening!

Q. I see on a lot of forum discussions that x company announced good news but the share went down...

A: The norm is traders enter a share on expected news, (hence buy on the rumour sell on the news) when that news is announced traders exit the position, if they are in profit and the news is good they may watch the share and exit later in the day, if the news is bad they will exit as soon as they can.

The same with results, although sometimes if the results are outstanding this may encourage traders to hold on for more profit and any traders exiting are replaced with new buyers.

Q. But how do Market Makers work exactly?

A: Note what follows is unofficial but it comes from an informed source -:

To lubricate their transactions, market makers need a supply, or inventory of the securities they support. This can either be real certificates, or via a process called 'stock lending' (don't worry about THAT one yet - it basically means they borrow stock or "pretend" they have it). Once you have an inventory of stock, and the concept of 'spread' (or 'edge'), a marvelous opportunity opens up. The average price at which a market maker accumulates a security and the average price at which he distributes it are going to be different. Add this to the fact that the market maker sets the price tick by tick, and boom! A license to print money. Observe closely, this is a good trick.

I, as a market maker, decide (for no real reason, or perhaps because there has been some trivial news about them) that stock in ABC Corp is my plaything today. I don't have much of an inventory in that particular security, so what do I do? Mark up the price so external holders will sell me some? No. I mark the price DOWN. Oof. Some external parties see this as a buying opportunity, and as I am a market maker, I am obliged to sell them the security at the new, lower price, meaning I am even shorter on that security.

Sounds mad, doesn't it? But it doesn't matter, because I mark the price down again. And again. And I keep on doing it till I hit the stops of external parties who are long, but weak, or the limit orders of people who are short. As a market maker, I know where these stops and limits are. I own the book, after all.

Ordinary Joe Public mostly think the market follows the laws of supply and demand, follows trend lines or fibs etc, which means they all tend to put their stops in similar places ('resistance' anyone? 'support'? That's right, it exists!). This is a game of chicken, really, and YOU will ALWAYS crack before ME (the market maker), because I can take the market to zero, or to the moon. You have to meet a margin call.

So now I am a market maker who has a LOT of supply of ABC Corp, which has fallen significantly in price. Looks like I'm holding a plum, doesn't it? What do I do next? That's right. I mark the price up. And I QUICKLY mark it up to the point at which the current price is ABOVE my average purchase price. So voila. I'm in profit. In a fairly big way. All I need to do now is unload this stock to you over a period of time at a price above my average, and I am rich. You, of course, sold it to me on the way down, and are regretting it because it is probably already way above where you exited (strange isn't it, how the market seems to 'hunt your stops', and then reverse?!) If I do this right (and it is an art form, for which successful brokers get paid multi-million dollar salaries), I create the illusion that the market is totally random, and is being driven by YOU, whereas I am simply a fee paid middleman, facilitating your activities. Even worse, I give you the vague impression that you are actually pretty good at it, and if you can only get your stops a little more accurate, you will stop losing money!

As I mark the price up, external parties start to worry they will miss out on this growth, and begin an ABC Corp buying frenzy, allowing me to unload. Everyone is happy. Most of the investing public are sitting on unrealised (imaginary) assets, while I am converting worthless shares into hard cash.

So, I have made a real, cash profit. You are sitting on an unrealised paper profit. We are all happy. Until I repeat the process and stop you out. Again. Are you getting the picture yet? In fact, once I have built a little momentum in a particular direction (long OR short) I can let you prolong it, settling simply for my spread profit. I know that eventually the run will peter out, and then I can force it the other way, easily dislodging those who took a position too near the end of that particular phase.

Let me paraphrase. When the market is zooming up madly, market makers are actually selling (usually stock they don't own!) in preparation for a subsequent managed fall, during which they can buy it back for less (i.e. make a profit). When it is crashing down, they are actually acquiring stock, in preparation for the process of selling it back to you at a higher price (i.e. make another profit).

Note: Market Makers can be quite devious. I held FEP some time ago and one day the shares started moving up, for no apparent reason. News was due but nothing was reported so investors assumed that perhaps it has leaked. A buying frenzy started, the shares moved ahead by 30%, but in a very short time the share price plummeted and was back to where it opened. I spoke to FEP about this action and was told that one of the market makers had a line of stock to clear. They raised the price to attract buyers, once the line was cleared they dropped it before most buyers could start taking profits. Only very few lucky and fast traders made anything that day, all other buyers paid over the odds for stock they either had to sell at a loss or were locked in to. That's one of the reasons I personally tend to be wary of stocks which are just MM controlled, preferring SETS or SETS/MM stocks, where I can see the order book (unless I'm very confident of a company's fundamentals). That said, I do sometimes hold market maker stocks...

Q. I'm seeing more sells than buys yet Rank Group is moving up!?

I'm puzzled at the market mechanics - looking at partygaming for instance today there were 755,000 sells and 369,000 buys so how has the market gone up 4% - do market makers buy those extra shares? if not who? I've seen the same happening for days on end with one of my key holdings Rank Group for instance today there were 1,400,000 sells and only 884,000 buys with the share price only moving down 0.5%. This has been going on for a few days with Rank and then all out of the blue you get the news that a big boy has increased his holdings - what's going on here?

A: I've had many a buy show as a sell and many a sell show as a buy, it's inevitable in a fast market. If a share price is moving up very quickly you can almost guarantee that a lot of the buys are being allocated as a sell (& vice versa for sells as the share price moves down quickly). Also, a lot of stuff goes through on Virt-X and PLUS, so you aren't even seeing all the volume. Buys and sells partly move the market but it's a whole load more complicated and there are no simple answers.

Also, note that Market Makers/systems do not tag any transaction as a true buy/sell, it is simply advfn/others electronic systems which place a buy or sell next to a transaction at the time it filters through as a "guesstimate". So I wouldn't lose sleep over it.

I would assume that if for instance there is a total volume of 500k of which 400k have been allocated as sells & 100k as buys yet the share price has risen, then I would assume that chances are that there have been more buys than sells. The buy/sell thing will drive you crackers trying to work it out, for me the volume is important and the next few days of the price usually gives the direction but not always.etc ;) Volume analysis is useful to suss out interesting situations or institutional accumulation.

Q. Bid - Offers prices - why does sometimes the offer price happen to be lower than the bid price by between 5% & 7%?

Normally the offer price is higher than the bid price, which I understand. However on 2 of the company shares that I hold I notice that at close today the offer price is actually lower than the bid price by between 5% & 7%. Do you know why this happens? Is it something to do with market makers? Is it good or bad news? - Andy

A: Actually, Andy the answer to your question is rather dull. Afraid it means nothing either good or bad. Between 4.30 and 4.35 shares go into an auction. The sell and buy prices are then reversed for a short time while the auction takes place. And, er it's as boring as that! Basically ignore the prices you see in the minutes after the market closes.

Q. Can market makers manipulate the buy/offer to have transactions wrongly tagged as SELL?

Let me explain. One share is currently @ 4.25 / 4.75 but 90%+ of the transactions going through the spread (closer to the BUY) are BUYs but comes up as SELLs on Level 2. Does that mean that L2 feed only tag a transaction as BUY or SELL based on which it is the closest to? And therefore MMs can create the assumption that a share is being massively sold when in fact it is being bought?

A: A way to check is to do a dummy buy/sell on your brokerage account and see what price market makersare actually prepared to give you but it does sometime occur that an actual BUY price is closer to the sell price which gives the impression of being a sell. I find it a good, short term indicator if you can sell shares closer to the BUY price than the SELL price because it means the MMs are very keen to buy shares. The dummy buy/sell on Selftrade is very useful but always worth checking.

Q. Why do I see less market makers on certain stocks?

Why do I keep seeing just 3 market makers on PartyGaming [PRTY} and some 9 for Sportingbet [SBT]? Surely this affects the liquidity of a stock?

A: Yes it does... Some stocks are covered by more Market Makers, it's that's simple. You'll find that generally mm's will want to get involved in a stock that is more volatile....easier to make money out of. If you look at Financials on ADVFN you will see who is covered by whom at the bottom of the page.

Q. But aren't market makers obliged to take trades, whether they like or not - they have, by law, to make a market!?

A: Yes as regards UK stocks, but only in their size which is generally small at their price, not the touch price. So it may be 125 - 126 on the yellow strip but one market maker may be quoting 125-130 and the other 121 - 126 both only in 5000 so if you want to trade in 10000 shares neither has any obligation to deal in anything over 5000...

In Sets stocks there are no market makers so no one is obliged to deal in anything with you...

Q. Who decides how much of an increment in market price and how long the market price keeps increasing for a share?

A: Shares of a company are mainly traded in a secondary market and if there were no sellers of a company's share then you would not be able to buy them. In practice share prices are mostly controlled by demand and supply so in theory there's no limit as to how much a share's price will rise (or fall). But of course this is also about liquidity - for a share price with no liquidity then the last traded price doesn't mean much. With market maker stocks the market makers have to quote exchange sizes according to stock exchange rules which could be as low as 500 shares for a small cap. So the screen price would display whenever 500 shares are traded but a telephone quote is still possible on a request for price and size. With bigger stocks like the ones traded on SETs the quotes are valid at any price..

Q. Why is there such a big discrepancy with the price quoted and the actual selling price on some shares quoted on Plus?

In my opinion the share prices quoted on Plus do not reflect the true value of any given share, now why is there such a discrepancy with the price quoted, and the actual selling price.

Fine, I know that there has to be a spread, but surely not so massive, let me give you two recent examples. Today, I asked R.B.S. direct trader to sell stock I hold in PLUS quoted company called Hello Telecom, on the Plus Board they are quoted at 10p but only one broker deals in that stock and in fact the selling price was 7p, and 11p to buy, that's a massive 33% down on the Plus quote, add dealing charges to the above figure and the losses are very significant indeed on the price quoted.

Another one I attempted to sell last month also quoted on PLUS was even worse, Trevor Baylis Brands (TBB) was quoted at 4p but again only one Broker was dealing in this Stock the selling price was a paltry 2p.

So if a stocks I.P.O. on plus is given a quote price, is that really a true reflection of what you can expect if you decide to sell, or have you already lost out, because the price quoted is not at all realistic.

We depend on these quotes, as being correct, but are they?

Maybe I was just unlucky, do you know any others who have been through a similar experiences on Plus, on the main London Stock Exchange markets, the selling price is just a small fraction below the stock quote, so why is it so different for PLUS quoted stocks?

A: You've just discovered what liquidity means. The less trading you get in a share, the wider the spread - and for microcap companies, on Plus, at the peak of the holiday season - the spread can be appalling. That's why my personal rule is to only invest in Plus-quoted companies where there's an obvious "outer" - such as them being a minority partner in an asset where the other partner is likely to buy them out.

As you've discovered, the mid-price is pretty meaningless, what matters is the bid price and the offer price. Yes - a spread of 44% on Hello is horrible, but then only £250-worth had been traded in the month preceding your sale. It's no wonder that the market maker was reluctant to buy your stock off you, which is why he had such a low bid price. You weren't obliged to take that price though - and a good broker would try to get inside the spread. However I suspect that someone like RBS isn't going to bust a gut trying to improve the price on a £700 deal - if you're going to deal in this kind of stock I'd suggest you get a broker who's prepared to work harder on your behalf.

In fact the liquidity issues you're highlighting have been affecting more and more shares on AIM and even in the lower reaches of the main market recently, if not to the extent of 40%+ bid/offer spreads. And that's universally a Bad Thing - the whole point of having a stock market is to provide liquidity in shares. It's why some investors won't touch any company under say £20-30m, it's too easy for them to become lobster pots. Easy to get into, almost impossible to get out.

 ...Continues here - Why do Market Makers Exist?

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