In another post, I talk aboutunderstanding Level 2 screens from a supply and demand perspective. This article builds on the supply and demand concept by focusing onis supplying and demanding shares of a stock. This doesnt matter as much to me for bigger board stocks, but I will always analyze the market makers for an OTC penny stock.

Market makers control the stock market, which means that the fate of your stock is in their hands. When you place an order for a stock, your order is sent to a market maker who fills the order for you. Think of a market maker as a middle man of sorts. If you want to buy 100,000 shares of a stock at $0.05/share, you send the order to your market maker and they present that order to sellers. Just like if you wanted to buy a house for $500,000, you would tell your real estate agent, and they would pass that offer along to the seller. Modern technology makes placing orders a speedy process that most give little thought to.  Its easy to look at a Level 2 screen and think of all market makers as equals, but each market maker is unique and understanding their behavioral trends can help you place better orders. As we know from aprevious article, supply and demand levels are what determine a stocks value. Knowing your market makers allows you to understand who controls the supply and demand for a stock, giving you a more thorough understanding of your market environment.

Different market makers will be important for different stocks. Its important to analyze the level 2 screen for each stock individually. Keep in mind, that different market makers may behave differently on each stock. The best way to figure out which market makers are important is by analyzing the level 2 screen for a couple of days to get a feel for how the stock trades. Look for things such as which market maker controls most of thevolume, how many shares the market maker shows vs. how many they actually sell, the size of the spread, and how fast the market maker allows the stock to move in either direction. I also like to check a stocks historical trading volume by market maker. Market makers are required to submit their reports of shares sold each month. The data comes out at the end of the month, so its not real time, but still a handy tool. You can check the monthly share volume report for a stock byclicking here.

Remember, the main focus is to learnhow a stock tradesand all analyses should be relative to this goal.

I dont want to talk too much about specific market makers, as that could take all day. Ill just cover some basics:

When most traders place an order to buy/sell a stock, it usually goes through a wholesaler or ECN (electronic communication network). Some popular market makers for these types of transactions include NITE, ATDF, ETRF, and ARCA. A look at a monthly share volume report will show you that these market makers handlea lotof volume. Certain brokers allow you to choose which market maker you route your order through, however, most discount brokerages such as E*TRADE will route it automatically. When I see these market makers on a level 2 screen, I will usually analyze the orders to gain some insight into the psychology of the traders in a stock. I assume that these orders have been placed by traders (not MMs) until being given a reason to assume otherwise. So, for example, if I see ETRF put up a bid to buy 100,000 shares of a stock, I will assume that was placed by a trader and not just an MM trying to balance the market. That being said, the latter is also a possibility and these MMs can still play games and manipulate a stock price. Regardless, analyzing these orders can give you some insight as to how traders/MMs expect the stock to move on a given day.

If you have been trading penny stocks for some time, youve probably heard the term dilution thrown around quite a bit. Dilution hinders a stock from running and can push the price down as well. Dilution is most noticeable when a market maker shows a certain amount of shares at a specific price, but sells much more than the amount shown (soaking up size). For example, VFIN may be showing 10,000 shares for sale but actually selling hundreds of thousands. When I see a market maker who is infamous for dilution on a level 2 screen, it is a red flag. Frequent dilutors include but are not limited to VFIN, VNDM, PERT, and VERT. I view dilution on a level 2 screen the same way I view a resistance level on a chart; price levels that will be hard to break.

Heres an example from last weeks trading of MYEC:

Anything catch your eye when you look at this?

The first thing I notice is market maker VNDM on the ask at .016. So, why is this significant? Ive been watching this stock for awhile, and market makers such as VNDM and VFIN will often sell massive amounts of shares at a certain price level (dilution), hindering the stock from going up.

If you just looked at this Level 2 screen from a supply and demand perspective, things would look great. Itappearsthat there is much more demand then there is supply, meaning the stock could run soon. Analyzing the market makers allows you to understand that there is probably a lot of supply around .016, making it difficult for the stock to run.

Thestock chartconfirms this. Below is a 5-minute intraday chart of MYECs trading action. Notice how the stock cannot break above .016 towards the end of the day. Every time it gets close, it is pushed back down as traders realize that it will be hard to break that price level.

Now, at the end of the day, VNDM moved his ask price up to .019.

To me, this means the stock has room to run up to that level, however, by this point it was too late. Many traders already got their shares for cheaper and have less motivation to push the price up. I bring this up because its another important point about the effects market makers have. Traders want to enter a stock when they think it has the potential to move up. When a market maker holds the price down through dilution, they make the stock less appealing. Additionally, a lot of buyers end up getting their orders filled at cheaper prices, meaning they have less motivation to buy shares at higher prices on the ask. Knowing that a stock has been diluted is a great way to understand the psychology of the traders involved.

Soaking up size is when a market maker buys or sells more shares of the stock than they show on the level 2 screen. If a market maker is soaking up size on the ask, theres a good chance its dilution and this is a bearish sign. If a market maker is soaking up size on the bid, that means they could be accumulating shares or creating a level ofsupport, which can be a bullish sign.

Many people make the assumption that market makers want to see a stock rise in price. Keep in mind that market makers can short sell a stock and profit on the way down.

One of the best ways to mess with the psychology of the market is to show big orders on a level 2 screen. Big orders on the bid make it seem like there is a large demand for the stock, while big orders on the ask make it seem like there is a lot of supply. These levels can act as mental support and resistance levels for traders using level 2 screens. Market makers know this and can place big orders to move the stock in a certain direction. For example, if I buy 100,000 shares of a stock at .03, and it runs to .04 where there is a market maker showing 5 million shares for sale, I (along with other traders) may sell the stock. The large order may not even get filled at all, however, its presence alone has an effect.

All this talk of shorting, soaking up size, and fake big orders can seem like a crazy conspiracy theory. Ill admit that there are some crazy market maker conspiracy theories out there, but its important to remember that market makers are traders. Just like other traders, market makers are trying to make money. Yes, it is their job to keep a balanced market, however, they are also responsible for remaining profitable. This is important to understand because it can shed light on a market makers intentions. For example, if a market maker shorts a stock at .02/share and the stock runs to .04/share, you could understand why the market maker may have motivation to push the price down. Dont get paranoid and automatically assume market makers are manipulating a stock; just be conscious of what is going on and look for red flags.

In no way is this article intended to be a comprehensive guide on understanding market makers. Ive barely brushed on the topic. My main focus is to stress the importance of knowing about market makers and how they operate. The best kind of analysis you can do is real-time. Observe different market makers and their behavior and do the research necessary to allow you to make smart trading decisions. Understanding the behavior of market makers can add a whole new dimension to your trading strategy.