How to Invest - Learning to Understanding Inside Spreads
One of the first steps in understanding trading is to define the players. What day traders really focus on are the activities of market makers. A market maker represents an institution (such as Lehman Brothers, Merrill Lynch & Co., Prudential Securities, and so on) that wants to make a market in a particular NASDAQ stock. The market maker is a specialist on an exchange or a dealer in the over-the-counter market who buys and sells stocks, creating an inventory for temporary holding. The market maker provides liquidity by buying and selling at any time. However, the market maker isn't under any obligation to buy or sell at a price other than the published bid and ask prices.
The downside of being a market maker is that you're obligated to purchase stocks when no one wants them. The upside of being a market maker is that you get to pocket the profits of a spread. A spread is the difference between a bid and ask price. For example, a stock with a bid and ask price of 15 1514 has a spread of 14. The bid price is $15, and the sell price is $15.25. By selling 1,000 shares at $15.25, the market maker profits by $250.
Spreads are often just a few cents for each stock. However, these pennies quickly become dollars because of high trading volume. Last year, NASDAQ market makers earned $2 billion from spreads. Day traders have sliced into some of these profits. Recent reports indicate that market maker spreads are down by 30 percent.
The existence of several kinds of spreads has caused some confusion. The following list defines some of these spreads:
Actual spreads paid: The narrowest measure of a spread, because it's based on actual trade prices. The actual spread paid is calculated by measuring actual.
Actual spreads paid: The narrowest measure of a spread, because it's based on actual trade prices. The actual spread paid is calculated by measuring actual
Dealer spread: The quote of the individual market maker. A market maker never earns the entire spread. The market maker needs to be competitive on either the bid or offer side of the market. The dealer is unlikely to be at the best price (the highest price if selling and the lowest price if buying) on both sides of the market at the same time.
Article Source: FxTradingStock.com
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Sara enjoys to teach investors the art of how to invest
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by: Sara Ferguson
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Date: Wed, 13 May 2009
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