4.
Prices; how do they work?
a.
What do the on screen prices reflect?
i.
The prices you see on screen are the best prices currently being
offered by any and all the Market Makers for the share you are looking at.
b.
Why do spreads change?
i.
Market Makers can and do change their spreads, but nowhere near as often
as you see the spread change on the screens.
(See 2h.)
ii.
The main reason that spreads change on screen is because the screen shows
you the best prices on offer.
c.
Why are some spreads so large?
i.
The stock may be very volatile and the Market Makers needs to protect
themselves from sharp price movements and market exposure.
ii.
The client (see 1e.) may have asked the Market Makers to reduce
volatility.
iii.
The price and NMS combination maybe so small that the Market Makers need
a large spread to ensure that they cover their costs and make a profit.
d.
What’s an inverted price?
i.
The prices you see are always “the best prices” it is possible that
Market Maker A is offering to sell the shares for less than Market Maker B is
offering to buy them at. Normally
the reverse is true, so this is know as an “Inverted Price”.
e.
Do Market Makers have to buy and sell at the quoted prices?
i.
Yes, so long as the quantity of shares you want to trade is equal to or
less than the NMS.
f.
How come my broker can sometimes get a better price than those onscreen?
i.
Basically because Market Makers compete with one another for business.
When your broker calls the Market Maker he is giving them the opportunity
to ‘bid’ for the business, the Market Maker may well improve on the price on
offer via the screens. The Market
Maker only makes money when they are buying and selling, so the Market Maker
will prefer to see the business go through their books at a reduce margin than
allow it to go to another Market Maker.
g.
What is Normal Market Size (NMS)?
i.
It is the quantity of shares for which the Market Makers are quoting
prices. IE for which the prices are
valid.
h.
Why don’t Market Makers set a price based on intrinsic value?
i.
The first person that comes up with a calculation that is 100% accurate
for 100% of quoted companies is going to be very rich indeed.
Market Makers no more ‘know’ the intrinsic value of share than you or
I do.
ii.
If they got the calculation wrong everybody would be buying or everybody
would be selling, leaving the Market Maker with huge market exposure.
iii.
Intrinsic value is still a notional value, since surely something is
worth exactly as much as they highest bidder is willing to pay.
iv.
Many investors value “in fashion” shares at far more than the
traditional “intrinsic” valuation methods would yield, again this would lead
the Market Maker having huge market exposure.
i.
How come I don’t see my trade listed?
i.
Trades for less than 3000 units don’t have to be reported.
ii.
Some stocks don’t have to have trades reported.
iii.
Your broker has batched up your trade with others.
iv.
Your trade was large enough to cause the Market Maker to treat it
differently, it will be reported at a later stage.
v.
Your broker arranged the trade via an alternative to Market Makers.
j.
Do Market Makers make money from the raise or fall in share prices?
i.
Probably not. Market Makers
make money from trading, at all times they try to minimise the open positions
they have, so the actual price of a share is of little consequence to them. (See
3.)
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Copyright Niro Computers Ltd 1999. This FAQ is maintained by Jason Ward.
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