Market Makers - What they do and no longer do

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By K.C. Grainger

True market makers are a thing of the past and this has a huge impact on the small cap mining stocks' price movements...old support levels are not support anymore

Over the last ten years, we have seen a decline in the number of true market makers in the smaller cap stocks; and worse yet, most have them have become active traders in the stocks that they previously made markets in. One must understand that a market maker (specialist is another term for market maker) in the past, would attempt to keep a neat market by trying to balance the bids and offers. They would fill a void during the times that there was not a match of sellers verses buyers. Remember, that there is not always a balance of buyers and sellers and much more so in less liquid stocks. In many stocks today, particularly small caps and juniors, there is rarely a perfect balance of buyers and sellers.

In the past, the market makers would assist buyers and sellers in the market by buying or selling or selling short in their own accounts. Their market making work would greatly enhance the liquidity of the market and diminish volatility. Naturally, they had a profit motive. They would make their profits by their "market making." Sometimes they would win, and yes, sometimes they would lose. In general, they win more than lose by taking advantage of their years of experience and the fact that they really "see the inside of the market" in who is buying and who is selling and above all else, "how much." They are truly "in the loop."

Previously, most market makers were employed by the brokerage houses that would support their trading activities with their firm's own capital. They would add a bit of price stability, some support to the price of a stock and really cut down on the volatility. But today, most of the brokerage houses engage the same market makers to be traders for the brokerage houses profits. That is where their profits are.

How to Address it Today?

Investors must realize that since there are no longer market makers as in the past, they must expect far more volatility and price plunges to levels far below where most stocks have bottomed previously. Stocks often sit and rot at prices that eventually may turn out to be "steals." One can lament and complain or perhaps take advantage by putting in bids for stocks that one finds appealing and waiting for the chance to invest in those stocks when they are often very undervalued. Couple the lack of supportive market makers with the fact that research coverage is often non-existent for small companies. Since there is very limited research coverage for most companies, the public is totally unaware of most undervalued stocks. The public usually only sees the narrow universe of stocks that the brokerage houses are recommending. Very few are undervalued...very few! And that is never going to change. Look at other sources for investment information, such as insider ownership trends, and make sure it makes sense to you.

K.C. Grainger is the editor of the Canaminvestor.com of Montreal, Quebec, Canada.