Mendacious "Bids" and "Asks"

Yesterday I mentioned a "doozie" of a scheme that came up in my mind as I was writing about the irrational stock market. Today, the scheme doesn't seem quite so fabulous as it did yesterday, but I hate to go back on my word, so I'll write it up, even if it does bore me to tears in doing so.

The average investor can hardly take advantage of this market strategy. Only the NASDAQ’s market managers and the big board's specialists have the wherewithal to put the scheme to profitable use, and from what I have seen, they do it whenever the opportunity presents. The scheme works best on the stocks of companies that pay dividends that are comparable to the interest paid on the short bond, say, around 5%. The stocks of many utilities pay such dividends. For the scheme to be actuated, the stock must be selling just below the price at which the dividend will assure that a bottom has been reached. If for instance the dividend is $1.00, the price should be less than $20.00, but not too much less. (Actually, the rational component of the market will not let the price sink too far below that level. The dividend will become more and more attractive as the price goes down.)

So, when the price begins to slide below the stock’s natural level, the market manager or specialist (hereafter, the insiders) will buy the stock for their own account, not meaning to keep it, but to store it up for use later in the session. Say, the price sinks to $19.50. at which level the dividend will now be paying at a rate of 5.1%, slightly more than the market will permit. So the insiders are taking no great risk in purchasing the stock. If the amount of stock the insiders were able to buy at the depressed level was not very much, they will simply sell it off at a higher price and make a pittance for their effort. But when the amount purchased is relatively high, the strategy comes into play.

In today’s high-tech world many thousands of amateur traders – and that many more pros – have access to real-time stock price information. Spreadsheet arrays display the second by second changes in four key quantities: the “bid-price,” the “bid-volume” – how much stock is desired at that price – the “ask-price,” and the “ask-volume” – the amount of stock offered at that price. The difference between the bid and ask is nearly always only a penny or so. If you wish to buy the stock you can do so immediately at the ask-price, or if the gap between the bid and ask is more than one penny, you can offer to buy at a higher bid-price which would still be lower than the ask. If you own the stock and wish to sell, you can do so immediately at the current bid-price, or if there is a gap, offer to sell at a price lower than the current ask. Those investors watching the changes in the bid and ask, and the quantities of stock offered at those prices, make their decisions to buy or sell by punching a few keys. Money changes hands, right then, in instantaneous real time.

A significant element playing in the minds of the online investors are those two volume quantities. If for instance, the “size on the bid” is very high in comparison to the “size on the ask” the investor will be inclined to believe that the price is about to go up. This would especially be the case if there were no gap between the bid and the ask, that is, the ask is exactly one penny higher than the bid. There would be no room for a higher bid, so those investors wishng to buy (as reflected in the huge bid-volume) would have to either wait it out – perhaps forever – or buy at the ask, and given that the ask-volume is in this case very low compared to the bid-volume, the urge would be to buy now rather than wait.

The opposite occurs when the ask-volume is much higher than the bid-volume. The urge to sell now rather than hope for a sale at the ask-price would be working in the investors ‘ minds. And that’s where the insider can couple his innate greed with his acquired knowledge to take advantage of les miserables watching computer screen arrays throughout the free world.

Remember, the insider has already accumulated a large quantity of a high-dividend stock, and he has done so at a price below the stock’s natural level. He may have been accumulating throughout the day, only able to put the strategy into play if the quantity he has been able to buy is sufficiently large. As the price rises toward its natural level, the urge to sell will naturally arise in many of those currently holding the stock. When the insider notices that the price movement has seemingly peaked, and the bid-volume is not so high, he will immediately offer all of his large stock for sale. If prior to that moment the ask-volume has been equally as low as the bid-volume the sudden appearance of a huge amount of stock for sale will encourage those holding at a profit (or at an acceptable loss) to sell at the bid. The price will go down a few notches until the sellers lose sight of the huge “size on the ask,” which may even be cancelled after the price slides a few cents.

So, who is the buyer of the stocks that are sold off? Well, the same insider who prompted the sale by posting the huge volume on the ask. He’s adding to his holdings, not content with a nice gain on the day, but using his cunning to make it a significant gain. As the afternoon wears on, and the price again rises toward its natural level, the insider will work the same strategy as many times as he can, until the volume he has been able to psych out of les miserables is more than he thinks he can sell at a profit when he permits normal (irrational) trading to resume.

Now it may seem that the insider takes the risk that he may not be able to sell all the stock he has accumulated. That’s where the dividend comes in. If he – or his surrogates – are forced by a total market sell-off to hold the stock for a long period of time, he’s still going to earn a dividend at least as high as he would have gotten in the bond market. But keep in mind: the chances of that happening are slim and none, since in a market sell off, the utility stocks paying reliable dividends will remain at or near their natural dividend level.

So, why can’t the average online miserable do this. Three reasons (there may be others): (1) the normal investor must pay brokerage commissions, and even if he’s buying in high quantities, the fees will almost never sink below one penny per stock. This will force the normal investor into larger gaps between his buy and sell prices. (2) The laws of the land require the normal investor to wait three market days before he can use the proceeds of a stock sale to make further purchases. So the investor must be playing with a large bankroll, one that is so large he can make repeated sales and buys throughout the market day. That’s doable, especially for those investors managing huge mutual fund accounts; they, being high volume traders, are probably exempted from the three day waiting period anyhow, but this is cold comfort to les miserables. Finally, (3), the average outsider investor, even if exempt from restrictions on the use of his funds, plays against the insiders, nearly all of whom do not pay brokerage fees; they are brokers in the purest sense of the word.

This is, of course, only one of the many games played by the insiders who control the flow of money in the stock markets. I’m sure they know many more ways to feed their greed that are not available to thee and me. But then, despite all their shenanigans, fortunes have still been made by outsiders. It’s just that their chances are about the same as those of a high stakes gambler, about 1 in 100. Let the insiders manage your money. They may every now and then steal it, but your chances are better that they won’t than that they surely will if you go into the lists against them.

On the other hand, if you just like playing games of chance . . . well, have at it, sport. There’s no chancier game in the world than the one being played on Wall Street.