[I212]In The Financial Markets

You probably take for granted that you can buy or sell a share or stock at a moment's notice. Place an order with the broker and within seconds it is executed. Have you ever stopped to wonder how this is possible. Whenever an instrument is bought or sold there must be someone on the other end of the transaction. If you wanted to buy 100 shares of McDonalds you must find a willing seller and visa versa. It is very unlikely that you are always going to find someone who is interested in buying or selling the same quantity at exactly the same time - this just does not happen. So - how does it work? This is where the MARKET MAKER comes in!!

The market maker is like a wholesaler. Customers arrive and leave all day long, some returning goods to the warehouse, others leaving with new purchases from 8.00 am until 4.30 pm every weekday (in the UK). The difference with this operation is that the wholesaler only has one item to trade, which are all identical. These items are continually bought and sold. The only responsibility that the wholesaler has it that he must keep his doors open during market hours, and he is responsible for setting the prices, second by second and hour by hour. He makes his money by buying at a lower price and selling at a higher price. This is known as the spread and has two components - a bid price and an ask price. He makes his money on the difference between the two which is his profit. This may only be pence or cents, but when you are dealing in 100's of millions of shares it is a vast amount of money.

Now - let me ask you a question - what happens when a customer comes in for a large buy order, but there are insufficient goods available. A normal wholesaler in the real world would buy in more goods from the manufacturer to fulfil the order. Our wholesaler does not have this option, he has to encourage people to sell to him, otherwise he has nothing to offer his customers. So what does he do? ( here's a clue - he sets his own prices for the market !!!) He has two options available. Firstly he could move his prices down fast and frighten people into panic selling. Alternatively he could move his prices up quickly, and encourage people to take some profits and selling. Lets assume that he decides to take the first course of action and he moves his prices down fast ( probably on the basis of some fictitious piece of news or gossip, or even a world event)

Surprised? - you shouldn't be. This happens every hour of every day of every week in all markets around the world. Is this market manipulation - yes of course it is. It also explains why markets fall faster than they rise - in the fall the wholesaler is in a hurry to get new supplies of goods, on the way back up he is taking his time making profits. This technique is known as ' shaking the tree' for obvious reasons!!! Naturally he cannot frighten everyone too much, otherwise he could end up with too many sellers and not enough buyers (he could of course have moved the prices up to encourage some clients to sell and take their profit - there is always more than one way to skin a cat!!!!)

The wholesaler is of course the MARKET MAKER. They are professional traders. They are licensed and regulated and have been approved to 'make a market' in the shares you wish to buy and sell. They are usually large internationally banking organisations, usually with thousands or tens of thousands of employees worldwide. Some of them will be household names others you will never have heard of, but they all have one thing in common - they make vast amounts of money. As you can now see (I hope) the market makers are in a unique and privileged position, of being able to see both sides of the market (supply and demand). They also have the unique advantage of being able to set their prices accordingly. Now - I don't want you to run away with the idea that the entire market is rigged, it is not, as no one market maker could achieve this on their own, but you do need to understand how they use windows of opportunity and a variety of trading conditions to manipulate prices.

The above explanation is of course a vast over simplification but the principle remains true. In America, the NYSE and AMEX have a single member known as a specialist that acts as the market maker for a given security. Other exchanges such as the NASDAQ, have several competing market makers for the same security. Do they ever work together? (I'll leave you to be the judge of that !!!!). On the London Stock Exchange there are official market makers for many securities (but not for shares in the largest and most heavily traded companies, which instead use an electronic automated system called SETS).

Now why I have spent so much time explaining what these companies do when actually you never see them at all. The answer is very simple. As professional traders they sit in the middle of the market, looking at both sides of the market. They will know precisely the balance of supply and demand at any one time. Naturally this information will never be available to you, but there is a way to interpret it from a chart using one single indicator. That one indicator is VOLUME. Whilst they will use every piece of news, world event, rumour and gossip to manipulate prices and the markets, this is one piece of information that they cannot hide (although even this they delay on larger orders).

Volume shows the activity of trading during the particular time period chosen which can be anything from 1 minute to 1 year. However, volume on its own does not tell us much, other than the number of securities traded in the period. Comparing one day with another tells us a little more, and it is then not difficult to see whether today's volume is high, low or average. If you have 20 people standing in a row, it is easy to see who is the tallest, shortest, and those of average height. However, add the volume to the price spread for the time period, and suddenly using common sense and the knowledge above, you can begin to start reading the market