# Market Makers



## Tostig (Nov 18, 2020)

The last post about Market Maker was in 2014.

I just watched the Netflix documentary about Bernie Madoff. Then I rewatched the series called Eat the Rich.

So I googled Market Maker and learned that pay per order services was not legal in Canada because there was an inherint conflict of interest with your broker (like Robin Hood) who uses them to make money in lieu of commission on trades.

Regardless, I sort of understand the need while I also question the need of a market maker's objective to provide liquidity in the market. But aren't they nothing more than institutionalized traders. Can they also lose money on trades? Are they obligated to buy every sell order and buy every sell order?

So one time I was trying to decide between the hedged ETF ZQQ and the unhedged ZNQ. I ultimately decided to buy ZQQ due to its average daily volume (30k vs 5k). However, I now think that because of the existance of a market maker, trading ZNQ would not have been a problem.

Back to the question about market makers being obligated to provide liquidity or how they avoid losing money. What if I had been skillful enough to have purchased ZNQ low at a limit order and now placed my sell limit order at a high price? When the actual ZNQ value reaches my sell order, is the market maker obligated to provide liquidity if my order was in board lots, or odd lots? What if the trends are downward and my sell price is obviously just a short term high? Will the Market Maker be knowingly buying high and then stuck with my shares looking for some other buyer to unload or just keep them until he can unload at equal or higher? But if my timing was right, ZNQ drops and I buy again, would I be forcing the market maker to lose money?

And then there's the BiG Short. Wasn't it a market maker that picked up Brownfield Fund's Credit Default Swaps at $80million? How could any buyer collect any money if all the underlying banks are bankrupt?


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## Covariance (Oct 20, 2020)

They are not obliged to transact with you. They are obliged to maintain an orderly market in the name. As long as there is an offer to buy they don't need to act. If there were no buyers at all they are supposed to put a bid up to ensure there is always a bid on the name. But that can be a wide bid ask spread. No guarantee you would be happy with what they are offering you.

WRT the Big Short question. I can not speak of the depiction in the movie. However, in real life CDS are over the counter (OTC), not traded on the market. So it would not have been the market maker since there isn't one. If I have a moment I will watch the movie and elaborate.


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## james4beach (Nov 15, 2012)

Tostig said:


> Back to the question about market makers being obligated to provide liquidity or how they avoid losing money.


Market makers are not always present. They usually are, but there are times they might step away. Examples I have seen over the years are: days with extreme volatility (market crashes) ; the last few minutes before market close ; and US holidays or semi-holidays. This is a reason you should avoid placing trades under those conditions.

Market makers always know the fair value of the ETF (the net asset value) and they won't lose money. They simply calculate the NAV, and then place a buy order some % below NAV and a sell order some % above NAV. As long as the market doesn't have some severe disruption, they are guaranteed to always buy below fair value and sell above fair value.

The market makers also don't necessarily pick up trades. Individual investors can often transact with each other directly, bypassing market makers. This is a very important reason you should *always use limit orders.*

Let's use your ZNQ example as it's pretty thinly traded. You look at the real-time quote and see
bid: 49.00
ask: 49.10

You can't tell what kind of person has submitted those orders at 49.00 and 49.10. They might be the market maker, or they could be other individual investors or institutions. Who knows.

*If you want to buy or sell this, you should (a) watch the ticker for a minute to see if it's stable, and (b) place a limit order at the mid point*. So if you want to buy, you'd do a limit buy at 49.05. Even better, if you have a way to estimate the fair value (net asset value) of ZNQ then you should place your limit at that price. You can estimate that relatively well by looking at QQQ in the US and calculating a "fair value" for ZNQ.

The main point is, choose a limit price somewhere between the "bid" and "ask". Calculating the mid point is a good rule of thumb.

To be more precise there, you unfortunately need to have access to Level 2 quotes, which will show you all the orders lined up. You can identify the market maker because they will be buying or selling a large # of shares. The fair value (NAV) is the mid point between the market maker's two orders.

Here's the cool part. Other individual investors will be doing the same. So if another retail investor also calculates the 49.05 mid point or fair value NAV, then you and the other individual investor will make a trade, bypassing the market maker.


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## james4beach (Nov 15, 2012)

How to get excellent fill prices on ETF trades in Canada


I really love Canadian listed ETFs but one of my frustrations is that liquidity is often limited. Sometimes there are wide spreads between the "bid" and "ask" prices, and it can be difficult to get reliable trade fills, or good prices for those fills. American exchanges have far higher volume...




www.canadianmoneyforum.com


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