The Market Maker Goldmine
Bernie Madoff went from being a relatively unknown name with the public to a highly recognized one in just a matter of months. And, of course, for all the wrong reasons.
But, what most people don’t understand about Madoff is that he made a great deal of his wealth not through his investments, but through his market maker firm. Avid traders knew his company as MADF on their Level II screens.
If you’re not familiar with market makers or their roles, these companies are registered to act as dealers in a stock. They buy, sell, and accumulate shares in a stock on behalf of their clients or for their own accounts. They fill both market and limit orders, and provide much-needed liquidity to maintain at least some level of stability in the stocks they feature.
So, how did Madoff’s firm – as well as other market makers – make so much money?
They do so in four basic ways. Market makers capture the spread between the bid and the ask price on orders, receive commissions from large institutional clients (such as mutual funds), get order flow from brokers, and trade for their own accounts. (Madoff was instrumental in developing the order flow aspect, in which market makers would pay brokers, such as E*Trade or Schwab, to funnel customer orders to them.)
All of this adds up – to a fortune – due to the sheer amount of trades processed each day. And, with the wild volatility and big movements we’ve seen over the past year or so, market makers are really making money.
It’s fascinating to watch market makers at work. You need a Level II screen to do this, and unless you know what to look for, most of the action will escape you. But, if you have a deep understanding of what’s going on, you’ll marvel at how adept market makers are at their craft, as well as how many tricks they employ on unsuspecting market participants to create even more profits for their firms.
While you may never be a market maker like Madoff or accumulate the amount of money he once had, you can see how a market maker operates by watching me in action it my classes. Trust me: It will be an eye-opener.