Market Making Game

[blindrat]

I'm trying to get my head around how to play this market making game I came across and would appreciate inputs from anyone!

Say you're a market maker, and you know the price of a stock. Starting with this your intention is to make a market for the stock. How would you go about doing this?

My initial thoughts:

If the initial price is 20

1) set b/a to 19-21.

say the broker decides to sell 50 @ 19

I was thinking the next move would be to drop the price a bit to induce a buy, followed by increasing the same to give the impression that the stock has hit a trough and is on it's way up, thereby forcing the investor to close his/her position, buying the stock. So for example -

2) b/a = 18-20
broker sells 25 @ 18

3) b/a = 19/21
broker buys 25 @ 21

4) b/a = 20-22
broker buys 50 @ 22

Do you think this sounds reasonable (both in terms of broker reaction and my strategy), or am I over-simplifying things here. Would increasing the spread help? Is this just a matter of supply and demand?

Thanks in advance!

 

[foredog]

In principle yes, but you may go 18.5 20.5 so as to leave yourself some margin or if you feel everybodys a seller you may go 17.5 19.5 because you want to get out of them quickly and not buy anymore until a few pence lower.

It's very rare to buy them at 19, go 20 offered, sell them for aturn go back to 19 21 sell some more call them up, buy some. otherwise stocks would never really move out of a narrow range

 

[blindrat]

In principle yes, but you may go 18.5 20.5 so as to leave yourself some margin or if you feel everybodys a seller you may go 17.5 19.5 because you want to get out of them quickly and not buy anymore until a few pence lower.

It's very rare to buy them at 19, go 20 offered, sell them for aturn go back to 19 21 sell some more call them up, buy some. otherwise stocks would never really move out of a narrow range

Thanks for that foredog. That makes sense. How do you think you could induce a buy (or a sell for that matter), other than trying to play with the psychology of the participant (trying to create the illusion of a 'peak' or a 'trough')? So for instance, if it's bought at 20.5, and you're now looking at buying to close the position for a profit, what do you reckon are the different ways to achieve this?

 

[buffting]

hi in this simple scenario where simple market mechanics (supply and demand) are prevailing nothing complicated.

If you provide a b/a and brokers are selling a fair bit - it would seem the market out there is a selling market for whatever fundamental reasons and as a market maker you would drop your b/a (keeping same spread, ur bread and butter) accordingly, because ppl in the market seem like they are in a rush to sell and you are able to buy at lower price.

After a certain period of price drops investors/brokers will want to start buying at these lower prices which is where u flatten out ur position and make the spread?

Would this be appropriate?

 

[foredog]

Not really, if you've been calling them down everytime you've bought then they may now be 15/17 but you may be long at an average of 18.5 so on the first buyer give them a little nudge up to 15.5/17.5, see another buyer and get them back up then you many make them 16.5/18.5 or even 17/19 to try and get them up, if they've ticked up 3 times in a row then people may think it's a breakout and they'll pile in!