Caught In the Middle

Traders Trade Secrets

Caught in the Middle

We need to talk a bit about what really happens when you buy or sell a stock.  We really do.  Too many traders see the Myth of the Stock Markets — not the reality.

The Myth — you buy stock in a corporation; you buy shares of ownership of that corporations.  And many believe that this money you pay for a stock goes to that corporation.

The Reality — the Stock Market is made by the ‘market makers”. These are firms that own gigantic, humongous, super-sized blocks of stocks.  Just like a shopping mall has a collection of stores.  The Stock Market has a collection of Market Makers.

A retail store, like Best Buy, purchases massive quantities of TV’s from Sony.  Best Buy takes a risk, by betting that they can sell those TVs at a profit.  When you buy the TV.  Your money goes to Best Buy, not Sony.

It’s the same with Stocks.  You buy your stock from the inventory of shares maintained by the Market Maker who is authorized to hold that Stock.

Why This matters

Here’s why this matters.  The Stock Market is NOT some “frictionless free exchange”.  It’s a corporate entity.  A collection of corporations (Market Makers).

And like any and every corporation on earth, what these corporations fear most is change — or more properly volatility.

And so the Market Makers have multiple ways to control stock prices — all aimed at controlling and reducing volatility to a tiny amount.  An amount that is more predictable.

The reason they do this is because Market Makers — unlike you and me — can make plenty of money on a tiny bit of volatility.  Because they trade massive volumes.  As an example, a 0.1% on a $10 million block of stock will net 10,000 in a single day for the Market Maker.

To be fair to the whole situation, this arrangement is helpful in some respects.  It does work to minimize constant corrections that can lead to losses for individual stockholders like us.

Of course it also minimizes the potential for gain. Unless you are a big fish.  A very big fish who trades a large portfolio can slowly but surely generate great wealth.

If all this sounds like a Casino, you are not far off in your thinking.  Casinos are extremely profitable operations that run on tiny winning odds (in favor of the house).  But “the house always wins”, and a constant stream of individuals are willing to feed the operation with their small losses.

Anyway, back to the Market Makers…. It is important to know that you are truly “caught i the middle”.  Playing at the Market Maker’s table.  Very, very little is ever said about these institutions.  Most have names you have never heard of.  They like it that way.

In the next article, we will talk about how to break out of being “caught in the middle”.

the Editors