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Market Maker FAQ v1.0

4.    Prices; how do they work?

a.        What do the on screen prices reflect?

                                                               i.      The prices you see on screen are the best prices currently being offered by any and all the Market Makers for the share you are looking at.

b.        Why do spreads change?

                                                               i.      Market Makers can and do change their spreads, but nowhere near as often as you see the spread change on the screens.  (See 2h.)

                                                              ii.      The main reason that spreads change on screen is because the screen shows you the best prices on offer. 

c.        Why are some spreads so large?

                                                               i.      The stock may be very volatile and the Market Makers needs to protect themselves from sharp price movements and market exposure.

                                                              ii.      The client (see 1e.) may have asked the Market Makers to reduce volatility.

                                                            iii.      The price and NMS combination maybe so small that the Market Makers need a large spread to ensure that they cover their costs and make a profit.

d.        What’s an inverted price?

                                                               i.      The prices you see are always “the best prices” it is possible that Market Maker A is offering to sell the shares for less than Market Maker B is offering to buy them at.  Normally the reverse is true, so this is know as an “Inverted Price”.

e.        Do Market Makers have to buy and sell at the quoted prices?

                                                               i.      Yes, so long as the quantity of shares you want to trade is equal to or less than the NMS.

f.         How come my broker can sometimes get a better price than those onscreen?

                                                               i.      Basically 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.

g.       What is Normal Market Size (NMS)?

                                                               i.      It is the quantity of shares for which the Market Makers are quoting prices.  IE for which the prices are valid.

h.       Why don’t Market Makers set a price based on intrinsic value?

                                                               i.      The first person that comes up with a calculation that is 100% accurate for 100% of quoted companies is going to be very rich indeed.  Market Makers no more ‘know’ the intrinsic value of share than you or I do.

                                                              ii.      If they got the calculation wrong everybody would be buying or everybody would be selling, leaving the Market Maker with huge market exposure.

                                                            iii.      Intrinsic value is still a notional value, since surely something is worth exactly as much as they highest bidder is willing to pay.

                                                            iv.      Many investors value “in fashion” shares at far more than the traditional “intrinsic” valuation methods would yield, again this would lead the Market Maker having huge market exposure.

i.         How come I don’t see my trade listed?

                                                               i.      Trades for less than 3000 units don’t have to be reported.

                                                              ii.      Some stocks don’t have to have trades reported.

                                                            iii.      Your broker has batched up your trade with others.

                                                            iv.      Your trade was large enough to cause the Market Maker to treat it differently, it will be reported at a later stage.

                                                             v.      Your broker arranged the trade via an alternative to Market Makers.

j.         Do Market Makers make money from the raise or fall in share prices?

                                                               i.      Probably not.  Market Makers make money from trading, at all times they try to minimise the open positions they have, so the actual price of a share is of little consequence to them. (See 3.)



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The latest version of this FAQ can be found at http://www.financiallinks.co.uk/Insider/InsiderIndex.htm.
© Copyright Niro Computers Ltd 1999.  This FAQ is maintained by Jason Ward.
This FAQ can be freely distributed, so long as the URL to the original and
copyright message remain intact.




Disclaimer : Please note that these articles do not necessarily represent the views of UK Share Net. The views expressed are those of the authors. The price of shares can go down as well as up. No infringement of copyright is intended, any offending articles will be removed as soon as possible when notified.
 
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