Old traditions die hard (some harder then others), particularly in the financial world.
With the vast number of shares traded every day on the stock exchanges, two traditional methods of trading are beginning to be obsolesced by tech-
nology, aided by some practices of which the regulators take a dim view.
Two traditional roles in stock trading—the trader and the specialist—are very much in the regulators’ sights.
Changes in the configuration of the market have altered and somewhat diminished the trader’s role in some respects. As a buying force on the exchanges, the role, once powerful, has diminished. However, the power surviving with the trader is sufficient to allow us to look back upon the trader’s previous influence with nothing less than pure awe. Years ago that job must have been even better than being a commercial banker. That was before NASDAQ became a major force - the electronic equivalent of a stock exchange without the venue of a physical location—and the heavy reliance upon the computer network for trading.
In the past, most good traders had substantial house funds available to allow active trading by taking positions in a stock (going long). Those were the days when information was scarce, spreads were erratic, and big prof- its could be made from smart trading. Now, with the computer, everybody knows everything immediately. NASDAQ, too, has siphoned off what were once the higher cap over-the-counter stocks. Spreads on the remaining OTC stocks are too narrow to make much money on active stocks, so traders widen the gap on lightly traded stocks to try to make more money there, and to compensate for the risks. The spreads, then, are too wide on inac- tive stocks. More brokerage houses, seeing diminishing chances to make money, are committing less money to over-the-counter (OTC) trading. OTC trading is being compacted into a business for some wholesalers who are growing, and may someday dominate the market. This may be com- pounded by the SEC reforms of over-the-counter trading, which can lead to a less competitive market with fewer participants. The brokerage firms themselves seem to be reluctant to bet their own money for their own accounts. Most of the trading now, and the reason for growth, is to service the growing demand by customers.
Are the traders the profit centers they used to be? It seems to be less likely than in the past, except for wholesale OTC houses that make virtu- ally all of their money trading, primarily in smaller, lesser known compa- nies—low cap stocks not big enough to be on NASDAQ.
At times, over-the-counter traders will still take positions in stocks they like in order to make an orderly market. However, these positions are not as strong as they were in the past. To the company involved, the size of the trader’s long or short position can make a profound difference in the suc- cess or failure of the stock in the marketplace. A good company can have
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four to six market makers. A very popular stock may have fifteen market makers, but that’s exceptional, and today, few stocks have that many.
Because of the losses that traders have sustained in the last few years, fewer traders will position stock these days. This reticence to take a posi- tion can make a mockery out of an orderly OTC market for the average small company. Short sellers can turn the mockery into shambles.
The best kind of trader to have supporting your stock is one who has a retail brokerage staff or institutional sales people in the company, because those salespeople can get some stock out at retail or with institutions.
Increasingly, at firms other than the wholesalers, the trader is there to serve just the retail operation, and so is subject to pressure from brokers as to what stocks should be traded.
If the trader is with a wholesale operation, then he or she is generally just trading with other traders, and that can go on just so long, and the stock can go just so high, before some of that stock has to get out into the retail channel. There is certainly little impetus for traders to bid a price up among themselves in most instances. The SEC has been taking a dim view of this practice, and is moving to correct it.
Traders don’t care whether the stock is going up or down, as long it is supplies volume. They work off the action. They get paid on the volume and on the spread, unless surprises, such as sudden swings, catch them on the wrong side of the market and there are some really severe losses. If they buy at $5 when the spread is $5 bid and $5.50 asked, they can sell at $5.50.
If the stock goes to $4.75 to $5.25, they can still sell at $5.25 what they bought at $5. A sixteenth of a point is important to them. A quarter is a nice profit, on volume. If the market goes to $5, they might sell and break even, but that’s a 10% move. And what if the stock rises?
These traders want to trade only on the numbers.They don’t want to know anything about the stocks they’re trading. They’re going for just the small price changes, which is an art in itself, and they want to focus on that, and not concern themselves with what the company’s actually doing.
They’re more concerned with who’s trading what, and what positions they have, and making a profit on a very small price movement.
Their emphasis is on every minute that prices change, and where they put the spread, and how wide they make it, and when they mark the stock up an eighth or a quarter or sixteenth and when they don’t over a specific period of time. Some of these decisions are based on the size and price of their positions. This is what creates a trading pattern and this is what makes the price go.
Frequently, the trader is armed with no more than the information required by securities regulation, which is little more than the company’s most recent financial performance and filings. Most of the smaller trading firms don’t maintain a research staff, and so the onus for keeping the trader informed must fall upon the corporation.
The younger, newer breed of traders are more likely to want to know about the companies whose stock they trade. They realize that it might help them to get a feel of where the stock might go, so that there’s less chance for them to get caught on the wrong side. This is clearly a trend, and one on which investor relations professionals should capitalize. Get to know your market makers.