How to Invest - Learning to Understanding Inside Spreads
One of the first steps in understanding trading is to indentify the players. What day traders really focus on are the activities of market makers. A market maker represents an institution (such as Prudential Securities, Lehman Brothers, Merrill Lynch & Co
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 15 151⁄4 has a spread of 1⁄4. 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 35 percent.
The existence of several kinds of spreads has caused some confusion. The following list defines some of these spreads:
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.
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.
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.