“I have a comment about your piece on finding the buyers. I thought the market makers were charged with and responsible for providing an orderly market for their securities. That means buying when everyone is selling and selling when everyone buys. To offset this risk, they charge (often criminal) spreads on these issues and hedge their exposure with options. (And they also run customers’ stops and limits to get more order flow, but that’s another story.) A good market maker shouldn’t have to halt trading in a stock if he’s providing adequate liquidity. And gaps should be kept to a minimum as well, except for the ones associated with news breaking when the market is closed. Am I missing something here regarding the role of market makers?” — Loren Siebert

Well, there are a couple of distinctions to be made here. The first is between “specialists” and “market makers.” The New York Stock Exchange, which is an auction market, works much as you say (except perhaps for the criminal part). Because there’s only one specialist firm for each stock — a very privileged position — specialists do assume the responsibility you describe. And some fulfill it more faithfully than others.

In a dealer market, on the other hand, there are as many market makers in a stock as want to be. They have no obligation to preserve an orderly market; they just do their best to offer attractive prices (to snag the trade) while making as much money as they can.

The second distinction is between routine trading and “an event.” You will recall that the questioner asked, When a stock is shocked by bad news and there is a torrent of sell orders, where do the market makers find all the buyers?

In routine trading, there is some stock at 40-1/4, say, and a seller comes in with 20,000 shares and there are no buyers at the specialist’s post (those round “islands” on the floor of the New York Stock Exchange, like atolls in the Pacific), the specialist will buy the 20,000 shares at, say, 40-1/8 or 40. He’s put up $800,000 of his own money. If he’s lucky, a buyer will soon appear to whom he can sell the same shares back for an eighth of a dollar more — he’s made $2,500 on his $800,000. If sellers keep coming without buyers, he’ll keep inching the price down in an orderly way as he buys more. Later, he’ll sell back the stock he’s acquired. He may have to do that at 38-1/2, if the sellers have just kept coming and coming and it’s taken a while for buying interest to show up — in that case he might have acquired 100,000 shares at an average price of 39-1/2 which he sells at an average price of 38-1/2 for a $100,000 loss (I’m just making these numbers up, to give you a sense of it) . . . but don’t cry for the specialists. They do OK.

The same thing happens in reverse if there are buyers but no sellers. A specialist may have shares in “inventory” he can sell. But once those are gone, he keeps selling shares he doesn’t own, knowing he will soon be buying them back.

But what of a sudden influx? The specialist’s obligation to make an orderly market does not extend to suicide. If there’s a “torrent” of sell orders, he will notch the stock down in a rapid series of tiny steps . . . or if there’s a large imbalance, he may ask for a brief halt either for news to be disseminated and/or to give potential buyers a few minutes to appear. Faced with orders to sell 2 million shares, the specialist is not going to buy them at 40 or even 36 and risk $80 million or even $72 million of his own money. He goes through the process of issuing “indications” that I described. Pretty soon, the market has found its new, lower level, and then the orderly trading resumes.

So the answer to your question is . . . yes and no.


“Please elaborate on the concept of the ‘specialist’ at the NYSE as mentioned in your column today. Does someONE actually have responsibility over each stock traded on the exchange? I guess I don’t quite understand the human dimension behind all the numbers.” — Mark

Well, it’s not one man or woman — and if he or she is out sick, the stock doesn’t trade. But close. Specialist firms tend to be quite small, and actual people do stand at their posts all day, heavily wired with their now-computerized “book” of good-til-canceled buy and sell orders, making a market. Each NYSE stock is traded at just one “post,” with just one specialist firm. Each such firm typically has charge over something like 10 to 40 stocks (don’t hold me to the exact number, but that’s the ballpark).



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