Avoiding Tricks by Market-Makers: A Broker’s Guide

The Nasdaq, renowned for its lightning-fast computer linkages, provides superior efficiency compared to other stock exchanges. However, despite its advantages, the Nasdaq trading process is not flawless. Market makers on the Nasdaq, who play a significant role in trading Nasdaq stocks, sometimes use tactics to deceive brokers and investors into believing they are receiving the best price when they are not.

Let’s delve into the strategies and schemes employed by some market makers.

Trick #1: Giving Phony Sizes

When a trade is sent to the New York Stock Exchange (NYSE) floor, it is directed to a specialist who may have limited interest in the transaction and aims to facilitate a quick buyer-seller match to provide liquidity.

Conversely, Nasdaq market makers engage actively in trading stocks, taking both long and short positions, and aim to profit from buying shares for their trading accounts and selling them to other buyers later in the day.

• Market makers may purchase shares for personal gain and reap profits by selling them later.
• They exploit rapid stock price changes to profit from the gap between order and execution.
• Using market orders instead of limit orders exposes trades to market maker exploitation.

Market makers may display fake sizes to entice traders into buying or selling stocks, creating a false impression of demand.

For instance, market makers might present bids and offers like: $10-$10.25 (75 x 10), indicating they will buy 7,500 shares at $10 each and sell 1,000 shares at $10.25.

Although Nasdaq rules mandate honoring these sizes, market makers may own stock positions, using bids for high share quantities to mislead brokers and investors into thinking the stock is in high demand.

How to Avoid This Trick:

While frowned upon by FINRA, this practice remains prevalent. If a market maker posts a bid, they are obliged to execute a purchase based on the bid.

To prevent falling prey to such tactics, observe a stock’s trading patterns before making transactions and familiarize yourself with key market players.

Trick #2: The Ticket Switch

When a broker submits an order, a clerk timestamps it and attempts to execute the trade. However, market conditions can change during this process.

How to Avoid This Trick:

Remember, market makers aim to maximize profits, and it’s crucial to monitor your orders closely to ensure transparency and protect your interests.

Trick #3: Jumping Ahead of Market Orders

Market makers can exploit market orders where you agree to buy shares at the current price, giving them an opportunity for potential gains.

How to Avoid This Trick:

To evade manipulation, opt for limit orders instead of market orders. This strategy enables you to specify the highest price you’re willing to pay, reducing market maker leverage.