Jon Corzine has recently become the latest U.S. big business villain. Although the demise of MF Global may seem like an event that people in my industry would rather not bring to light, companies like this are important for traders to recognize and be wary of.
What many traders don’t know is that MF Global (MFGLQ) was one of the largest market makers on Wall Street. Market makers are important to recognize, as they constantly try to trick traders so they can profit from their mistakes.
If you are not familiar with market makers or their roles, these companies are registered to act as dealers in a stock. They buy, sell, and accumulate shares in a stock on behalf of their clients or for their own accounts. They fill both market and limit orders, and provide much-needed liquidity to maintain at least some level of stability in the stocks they feature.
Unlike specialists who operate on the floor and deal with NYSE stocks, market makers work out of sight, executing orders by computer or sometimes by phone. Smaller firms may only dabble in a few stocks, while bigger firms may operate in a couple dozen.
So, how did Corzine and MF Global, as well as other market makers, make so much money?
They do so in four basic ways:
- They capture the spread between the bid and the ask price on orders,
- They receive commissions from large institutional clients (such as mutual funds),
- They get order flow from brokers
- They trade for their own accounts.
These four methods allow the market makers to acquire a fortune due to the sheer amount of trades processed each day. Additionally, the wild volatility and big movements we’ve seen over the past few years has ensured that the market makers are constantly coming out on top.
It’s fascinating to watch market makers at work. A Level II screen is necessary to see them, and unless you know what to look for, most of the action will escape you. But once you develop a solid understanding of what’s going on, you’ll marvel at how adept market makers are at their craft, as well as how many tricks they employ on unsuspecting market participants to create even more profits for their firms.
While you may never be a market maker like Corzine or accumulate the amount of money he once had, you can see how a market maker operates and how to avoid their traps by watching me in action it my classes. Understanding Level II will give you a big leg up on the market makers and help keep them out of your wallet!
Fausto Pugliese is the founder and president of Cyber Trading University, a world leader in online education and training for traders and investors in the markets. You can reach Fausto at [email protected] or follow him on Twitter and Facebook.
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