Stock Market Basics: Market Makers, News, Volume and More!

Forget all you have read, heard or ever been told about how the financial stock markets work. You are about to find out how stock markets really work. It may surprise you, it may not, but you need to understand how things are and not what they appear to be if you are to succeed as an online trader both trading and investing. So lets start with the stock market basics.

Naturally none of what you are about to read can ever be proved, for as you will see the major players have been practising their skills for centuries, waiting for more unwitting victims to enter the market. So please read the following with an open mind and if it makes sense to you then just believe that this can and does happen every single day in the market, whether the markets are rising or falling, whether winter or summer, busy or quiet!! I have written several articles on the subject which have all been published and whilst some may disagree with my views and thoughts on the subject, when you think about it logically, then with so much money to be made you would probably act in exactly the same way

Stock Market Basics: Introduction

Before I go on to explain how the stock markets REALLY work, if you click here it will take you to the articles archive about market makers. This was an article I wrote for Working Money, and which is a parable of how the stock markets really work! Now you may or may not believe what you have just read, but with over 300 years of experience they use every piece of news to manipulate prices. You only have to look at the last few months in the US sub prime markets and the subsequent turmoil to realize that this is a golden opportunity for them to move the markets down fast, and pick up cheap stock as everyone panics and sells!

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Stock Market Basics – The Market Makers

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 stockbroker 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 stocks 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! They cannot be avoided, but if you know how they work, you can watch them buying and selling in the market, and the tricks they play to take your money!

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 stock 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 ( or stocks) 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 MOVES HIS PRICES DOWN FAST -Surprised? – you shouldn’t be. This happens every hour of every day of every week in all stock 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!)

Stock Market Basics – Market Manipulation Using The News

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 international 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 of stocks, shares, options etc ).

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 stock 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. They will any and every piece of news to move the prices, whether relevant or not. Have you ever wondered why markets move fast on world events which have no bearing – this is the reason why, and strangely a few days later, prices bounce back!

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. (Go back to the charts on the technical-fundamental page and have another look). Whilst they will use every piece of news, world event, rumor 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). Just look at the chaos in the last few months that have been caused by the sub-prime lending market – the market makers have taken full advantage after the last few years of a bull market!

Stock Market Basics – Volume, The Only True Indicator

Above are some of the stock market basics which I hope have highlighted some of the dangers involved in trading if you fail to understand how the game is played. Now before you lose heart and give up, we do have one element our side which cannot be hidden from view and that is volume. Volume is the one true indicator and tells us all we need to know and provides an insight into what the market makers are doing, every second of every day !Each day we can see on the stock market index chart 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.


Now, in order to try to demonstrate the theory, I have drawn a couple of simple examples which I hope will make the point. The first one is on the left, so lets see what’s happening here. The price spread is wide on day 1, but gradually narrows in days 2 and 3, until the price spread becomes very small on day 4. On its own this does not tell us very much, but now lets look at what’s happening with the volume. The volume on days 1, 2 and 3 is increasing as we would expect – it takes effort to move prices up, and volume = effort – but wait a minute, the price spread is narrowing, yet there is more effort going in every day in terms of volume. Is the professional money starting to struggle to get prices higher? On day 4 we see a very narrow price spread, and look at the volume, it is almost double that of the first day.

There is practically double the effort going in by the market makers, but with no resulting increase in price. This suggests that they are struggling to dump stock onto a market that is not interested in higher prices, because if it were with all that effort going in, the prices would be rushing upwards – they are not.

Stock Market Basics – Volume Spread Analysis

The conclusion we have reached above is based in a simple analysis of the volume, and the resulting price activity ( the spread on the candles) This is called volume spread analysis, and forms the basis of technical analysis.

As we have seen the market is not interested in a move higher at this stage. The professionals are struggling to get prices higher as shown by the high volume which is having no corresponding effect with a very narrow price spread. We therefore conclude that this price will probably fall in the next few days once they have cleared most of the stock from their books – A VERY SIMPLE CONCLUSION!!

OK let’s look at another simple example shown here on the right. The price spread is wide on day 1, the same on day 2, and wider still on day 3, but what’s happening with the volume? On day 1 it is what we would expect, but on day 2 it is less than half and on day 3, practically nothing. If this were a true move up, wouldn’t we expect to see the volume ( effort ) increasing as the prices increase and the spread becoming wider – after all it takes effort to get prices higher. This all looks very suspicious. So we conclude that as the market is moving higher on very low volume, there is something odd going on here! This is a classic move that you will see time and time again, particularly first thing in the morning. It is those rascals, the market makers moving prices up to ‘sucker in’ some mug punters into buying.

They are simply moving the prices, but with no support by the professional money. We therefore conclude that the prices will fall shortly, and probably quite sharply. This is how the stock market and financial markets really work!! I hope from the above simple examples that you begin to see how it is possible to draw meaningful conclusions for your online trading,  just by using these two simple tools of volume analysis and price spread. Having covered the stock market basics we will now go on to look at the charts in more detail and something called Japanese Candlesticks !

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