In many ways, the Nasdaq is more efficient than the major stock exchanges because it uses lightning-fast computer linkages, which are typically "open cry" floor models. However, the process associated with bidding for stock and executing a Nasdaq trade is far from perfect. In fact, in spite of the quick "fills", Nasdaq is also known for giving market makers, who make their living trading Nasdaq stocks, ways to fool brokers and investors into thinking that they are truly getting the best execution price, when in fact they are not. For this reason, brokers need to ensure that they and their customers are being treated fairly by being aware of the tricks and gimmicks market makers use.
Trick #1: Giving Phony Sizes
When a trade is called into the floor of theNew York Stock Exchange (NYSE), it is immediately routed to a specialist in the stock, who often has limited interest in the individual trade. Because the specialist is being inundated by traders, he simply wants to find a buyer or a seller for your stock as soon as possible. Essentially, he is an intermediary, who sometimes takes positions in stock, but is really there to function as a liquidity provider.
However, Nasdaq market makers, routinely take positions in stocks, both long and short, and then turn them around for a profit, or a loss, later in the day. They provide liquidity, but they are also more focused on capitalizing on your lot of stock by buying it for their own trading account and then flipping it to another buyer. In any case, market makers will sometimes post phony sizes in order to lure you into buying or selling a stock.
For example, market makers may post a bidand an offer that looks something like this:
This means that they will buy 7,500 (multiply 75x100) shares of your stock at $10 per share and they will sell 1,000 shares of stock at $10.25. They are obligated under Nasdaq rules to honor those sizes. However, there is a chance that the market maker already owns a position in the stock, and by posting a bid for 7,500 shares, he is merely looking to fool brokers and investors into thinking that there is big demand for the stock and that it is moving higher. (To read more on this subject, see Electronic Trading Tutorial and Markets Demystified.)
Note on this subject: While actions such as this may be frowned upon by the National Association of Securities Dealers (NASD) - they are still fairly common in practice. Also, if someone tries to sell 7,500 shares to the market maker, he must buy them because his bid is posted.
So what happens? Most brokers will simply pay $10.25 for the stock just to get the trade done, but in reality, the purpose of posting a big bid was to sell the market maker's 1,000 shares at $10.25 to the unsuspecting broker. The trick worked! Incidentally, the same trick can be used in reverse on the sell sideof the equation. The market maker may show a big offer of say 10,000 shares. Brokers see this, think that the market maker is looking to unload a big block of stock, and quickly sell their shares at the bid price (which, using the above example, is $10). In this case, the trick works again because the market maker fools the broker into selling his shares at $10, precisely where he (the market maker) wanted to buy them.
| How to Avoid this Trick: Watch a stock trade before buying or selling it. Learn the players in the stock. By watching the action on a "level 2" or "level 3" screen, you can tell who is accumulating shares or unloading them. With this knowledge, you\'ll have a better idea of whether the sizes the market maker posts are real. (To learn more, read Introduction To Level II Quotes.) |