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Market Makers. Who are they and why you should know

The age old question many traders and investors ask me is, why do I get into a position during the first hour of trading and usually get crushed? The answer is simple. Market manipulation. But by who? The answer is simple. Good old market makers.

First, let’s go over who they are. Market makers are basically the middleman for buyers and sellers. They are employed by the big firms such as Goldman and Morgan Stanley. They are also known as specialists as you will see them referred to on CNBC and Bloomberg. They ensure proper and efficient order flow and create an environment where buyers and sellers have a liquid trading experience. Now they usually don’t earn a commission. They are mostly salaried and ensure that their firms make money as they hold large amounts of stock which they buy and sell each and every day.

They make money by profiting on the bid / ask spread. Ever wonder why there are spreads and sometimes they are wider in the options markets than in an individual stock. That is their bread and butter. Case in point, if XYZ stock is trading at $10.00 a share. The spread could be $10.00 – $10.10. That 10 cent spread is where they make money. Now you can say that’s such a minuscule amount. However, consider how many millions of shares trade in an individual stock on any given day. It’s astronomical.

You must be asking yourself, what does this have to do with market manipulation? Well here comes the fun part of this article! Keep in mind that the first 30 minutes of the trading day is the most volatile. Why is this? Because a stock has to set it’s high and low, potentially close any gaps from the previous day and let’s face it. Big banks and funds shaking out weak hands to make their money. Now as a retail trader we are out to get crumbs from this massive pie called the market. The market makers represent huge firms with huge sums of money. So on a given day, the market could open flat to slightly lower and once the bell rings the stock drops and a decent amount at that. You are saying to yourself, let me get short and ride this trend. All of a sudden it stops dropping and just kind of consolidates at the bottom and starts to spike up. You panic and cover your short at a low. Scratching your head in astonishment. What just happened here? Don’t feel discouraged. This happens to the best of us and to most retail traders.

This also happens in reverse. Going long into a huge spike, just to watch your long position turn against you. This is what we call shaking the weaker hands out of the market. Market makers will buy on the way down and short on the way up. The herd mentality is to quickly jump on the bandwagon however they have other plans. This sadly happens every day and won’t stop anytime soon. Take some time out to observe these day to day occurrences in various stocks and you will see just how often this happens. I mean hindsight is always 20/20 so we can’t know what will happen every time but when it happens 90% of the time then I mean wow. You can’t be going crazy. It’s definitely happening.

What can you do to protect yourself from this market manipulation? Develop a strategy to trade reversal patterns. Watch to see the first candle or two after the market opens and see where the strength is heading. Once it starts to consolidate and develop higher lows on a drop or lower highs on a spike then you know an opportunity is presenting itself. There is much more to this than just watching for these signals. There is volume, momentum, price action. All of which are important in deciding which position to take. The bottom line here is to be prepared and know that even though the market as a whole is pretty efficient, there are ways you can be shaken out a position and leave you wondering why. Before taking a trade consider these factors I’ve outlined and you might be surprised to know just ow much you’ve been being fooled by these guys.

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