let's suppose you've survived the ravages of ignorance, greed, false hope, fear, and bragging. now, to stay alive in the market, you must outwit the market makers.
market makers (mm's) are financial "institutions" whose role it is (supposedly) to maintain orderly markets (by preventing extreme volatility- again, "supposedly"), and to make a market for the stocks they handle.
okay, enough with the "supposedlies". these people don't give a rat's a** about being orderly OR making a market. all they care about is making money for themselves. their methods include craft, stealth, and outright violations of the law. some people say it even includes criminal conspiracy.
when you see the bid/ask/last on an OTC stock price, those are set by mm's. ask is the price at which you can buy the stock; bid is the price at which you can sell the stock; last is the price of the last transaction.
there are dozens of market makers. when bid/ask prices are posted (often changing within seconds), the bid price is posted from the mm with the highest bid price, and the ask price is posted from the mm with the lowest ask. so you would think it's a competitive market. many observers doubt this, however, and accuse the mm's of price-fixing, i.e., criminal conspiracy to fix prices. they also accuse the SEC of lax enforcement. be that as it may, there's little you can do to directly change the way things work. (ummm- actually, in a later blog i'll cover what some people are planning to do to "encourage" the SEC to do a better job).
for now, your main issue is how to avoid getting beat up by the mm's. and this is a good time to cover short selling, or "shorting", and in particular, "naked short selling", i.e., NSS. as a retail trader, in certain stocks (not pink sheets) you can engage in shorting for profit. here's how it works:
you must have a margin account (in FOREX, your cash balance is your available margin- but here i'm only talking about stocks, okay?- i'll get to FOREX in a later blog). using your margin as surety against being wrong, you borrow some stock from your broker at the current price. your broker will then sell those shares into the market for you. if the price goes down, you make money. for example, if you shorted 1000 shares of ABC at $5 a share ($5000 your total trade), and it then drops to $4 per share, and you decide to buy the shares back at that time, you would make $1000 profit. but, if the price goes up to, say, $7 per share, and you decide to buy the shares back at that time, you would lose $2000. if you get to a point where your loss is greater than your available margin to "cover", you'll get a margin call from your broker to ante up some more cash or they'll buy the shares back and you eat the loss up to that point.
brokers make money a couple ways here: if you're right and the price goes down, they make special commissions; if you're wrong and the price goes up, they make the commissions AND (probably) a big chunk of that cash you lost. to understand this last bit, think of yourself as a broker. here comes some stupid client who wants to short a stock that you figure (based on what your quants tell you) is sure to go up. so you know your client is going to be a loser and will either bail when things get rough or not bail and go all the way through their available margin. what do you do? well, you analyze how much cash reserve you have, balance that against how many shorting knotheads you have that day, and "maybe" choose to not even "actually" place their trades, to the extent that you can stand the risk. then you just sit there and collect the money when things go bad for your clients, i.e., you get to keep the value of the whole transaction, instead of just some commission crumbs. like the song says, "nice work if you can get it". if you're wrong, and things go well for any clients, you simply pay them what they should have made on the trade. but the odds were always in your favor, get it? and by the way, it's another reason why brokers pay quants such astronomical salaries- and yet another reason why YOU should learn quant. whattolearn.com.
so what is NSS? NSS (naked shorting) is the selling of shares you don't actually own, i.e., you are selling "ghost shares", "counterfeit shares", "fraudulent shares".
this post is getting long enough.... continued next post
market makers (mm's) are financial "institutions" whose role it is (supposedly) to maintain orderly markets (by preventing extreme volatility- again, "supposedly"), and to make a market for the stocks they handle.
okay, enough with the "supposedlies". these people don't give a rat's a** about being orderly OR making a market. all they care about is making money for themselves. their methods include craft, stealth, and outright violations of the law. some people say it even includes criminal conspiracy.
when you see the bid/ask/last on an OTC stock price, those are set by mm's. ask is the price at which you can buy the stock; bid is the price at which you can sell the stock; last is the price of the last transaction.
there are dozens of market makers. when bid/ask prices are posted (often changing within seconds), the bid price is posted from the mm with the highest bid price, and the ask price is posted from the mm with the lowest ask. so you would think it's a competitive market. many observers doubt this, however, and accuse the mm's of price-fixing, i.e., criminal conspiracy to fix prices. they also accuse the SEC of lax enforcement. be that as it may, there's little you can do to directly change the way things work. (ummm- actually, in a later blog i'll cover what some people are planning to do to "encourage" the SEC to do a better job).
for now, your main issue is how to avoid getting beat up by the mm's. and this is a good time to cover short selling, or "shorting", and in particular, "naked short selling", i.e., NSS. as a retail trader, in certain stocks (not pink sheets) you can engage in shorting for profit. here's how it works:
you must have a margin account (in FOREX, your cash balance is your available margin- but here i'm only talking about stocks, okay?- i'll get to FOREX in a later blog). using your margin as surety against being wrong, you borrow some stock from your broker at the current price. your broker will then sell those shares into the market for you. if the price goes down, you make money. for example, if you shorted 1000 shares of ABC at $5 a share ($5000 your total trade), and it then drops to $4 per share, and you decide to buy the shares back at that time, you would make $1000 profit. but, if the price goes up to, say, $7 per share, and you decide to buy the shares back at that time, you would lose $2000. if you get to a point where your loss is greater than your available margin to "cover", you'll get a margin call from your broker to ante up some more cash or they'll buy the shares back and you eat the loss up to that point.
brokers make money a couple ways here: if you're right and the price goes down, they make special commissions; if you're wrong and the price goes up, they make the commissions AND (probably) a big chunk of that cash you lost. to understand this last bit, think of yourself as a broker. here comes some stupid client who wants to short a stock that you figure (based on what your quants tell you) is sure to go up. so you know your client is going to be a loser and will either bail when things get rough or not bail and go all the way through their available margin. what do you do? well, you analyze how much cash reserve you have, balance that against how many shorting knotheads you have that day, and "maybe" choose to not even "actually" place their trades, to the extent that you can stand the risk. then you just sit there and collect the money when things go bad for your clients, i.e., you get to keep the value of the whole transaction, instead of just some commission crumbs. like the song says, "nice work if you can get it". if you're wrong, and things go well for any clients, you simply pay them what they should have made on the trade. but the odds were always in your favor, get it? and by the way, it's another reason why brokers pay quants such astronomical salaries- and yet another reason why YOU should learn quant. whattolearn.com.
so what is NSS? NSS (naked shorting) is the selling of shares you don't actually own, i.e., you are selling "ghost shares", "counterfeit shares", "fraudulent shares".
this post is getting long enough.... continued next post
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