In this video, Brandon shares how to calculate bid & ask spreads, which are generally published by market makers and securities dealers. Then, he goes over an Achievable practice question together with you to ensure you understand the concepts you’ve learned.
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00:00:00 Whether or not an order will be filled in its entirety in relation to, say, the designated market maker's book or even just a regular market maker's book, these are tough questions, No way to get around it. But we're going to take a look at a question together and I'm going to share with you what my thought process is and how I consistently get to the right answer on these questions. And hopefully this helps demystify this concept a little bit for you. Immediately, let's put this practice question up on the board. If you're feeling confident, feel free to pause the video, see if you can answer the question. 00:00:30 On your own and as soon as you hit play, we'll talk about it together. OK. Think you know the answer. All right, let's see. The Designated Mark Makers book displays the following inside quote, 9350 by 9366 by 8. The question is which of the following orders placed by a broker dealer on behalf of a customer would not be filled? 00:00:51 Immediately in its entirety, let's go back to the very beginning. The DMM that is a designated market maker. We call them the Specialist. If you've ever watched a news channel cover something in the New York Stock Exchange and you see those people on the floor dressed in blue, those are designated market makers. In reality, the DMM is part human, part machine. We really refer to the humans as Dmm's, but a lot of what they do is computer driven. Now they do sometimes get into the market trade manually, but oftentime. 00:01:21 Times the Dmm's on the New York Stock Exchange floor are just making sure the computer systems that are matching people's orders, buying and selling directly with customers, they're making sure that those systems work and function correctly at least most of the time. And the New York Stock Exchange is considered an auction market. If you've ever been to an auction, it kind of works like a typical auction where some parties are selling things and people are bidding on on buying those things and their prices being thrown around. It's just a little bit more efficient than your traditional like auction where people. 00:01:51 Like yelling out prices and it's in person. It's a little more computerized and fast. Either way, let's look at the question and see if we can better understand this concept. What we've been given is an inside quote. Now, an inside quote references the best prices on both sides of the market. And when I say both sides, there's always two sides in any transaction. Investors can buy securities and they can sell securities. There's always going to be a difference between your buy price and your sell price. What we're looking at here is what we call a bid ask spread. 00:02:21 9350 is our bid, 9360 is our ask and depending on what your role is in this mix, those numbers will mean different things to you. Now first let's go back to the language I just used bid and ask. Those terms are from the perspective of the designated mark and maker. And by the way it's the same thing for regular mark and maker is on NASDAQ. 00:02:43 Same exact concept. When they say the word bid, that is the price that they are willing to buy stock from their customers At bid means buy, right? If you're bidding on something, you're trying to buy something. And that's the idea. But the key is being aware of who's doing the buying. This is the designated market maker or just the regular market maker. If it's in NASDAQ, this is the price they're willing to buy from the public. If that is the price the designated market maker's willing to buy, then I as their potential customer I. 00:03:13 Know that that's a price I can sell stock to them at. This is a tricky concept because a lot of people hear the word bid and automatically think buy. But there's a buy and a sell represented at the bid. It's the professional, the DMM, the market maker. They're the ones buying their customers or just plain old investors that are looking at trade securities. The bid is where they would sell. Now on the other side, if I publish an asking price for something, I'm trying to sell something. And again, this language is from the DMM. 00:03:43 Or the market maker's perspective, they're willing to sell stock at 9360, just like we saw on the bid side, there's a buy and a sell over here too. Now if the DMM is selling at the ask, that must mean their customers or investors are buying at the ask. By the way, side note, former teacher of mine always used to say, hey, if you're a customer of a market maker, you got to payout the ask. 00:04:06 I don't know. Maybe that helps. Let's go ahead and try to summarize these points. I can't emphasize this enough, at least in relation to this concept. You have to be comfortable with switching perspectives. Dmm's and market makers buy at the bid, sell at the ask. They're customers, which are basically regular investors. They are selling at the bid, buying at the ask. Now if you think about the DMM or a market maker, kind of like a car dealership, they work basically the same way If I go to a car dealership and I want to go. 00:04:36 Sell a car to them. I, as the customer, will sell the car to them at a marked down or a low price. The dealership would buy the car for me on the other end. If they bought that car, they would then put it back on their lot and then try to sell it at a higher price and some other customer would then come and buy at that higher price. The point is the customers get the worst deal between the two numbers. Customers buy at the high price and they sell at the low price. And that's how Dmm's and market makers have to function. They're the ones making the. 00:05:06 Profits, They're the ones buying low and selling high. That's what keeps them in business. That's what keeps them offering this service to investors. And yeah, investors get the worst deal, but again, that's just how business works. Now below that we see 6 by 8. That is what we refer to as the size of the market. These numbers are in round lots. So what this means is that there are 600 shares available on the bid side and 800 shares available on the ask side just because a DMM or a market maker publishes a price that they're willing to buy or. 00:05:36 Sell it. For example, let's look at the bid. They're willing to buy stock from the public at 9350. Does that mean they're willing to buy a billion shares at 9350? No, they're going to set a limit to it. And this is their way of saying, hey, we're willing to buy stock from you at $93.50, but we're not willing to buy more than 600 shares at that price. If you want to buy more from us, it's probably going to be at a higher price. That's what the size of the market tells us. Now let's go to the question and see if we can utilize this knowledge to answer it correctly. 00:06:06 Question says, hey, we have 4 scenarios here. Three of them can be filled in their entirety. One of them can't. So one of these orders are asking for more than what the quote provides. The customer is either asking for a better price than the DMM or market maker's best price, or maybe they're asking for more shares to be traded than the size of the market. And again, we need to be aware that this is from the customer's perspective. With that being said, let's look at the first answer a customer wants to sell. 00:06:36 500 shares and $93.53. They're selling. Investors sell at the bid. They sell at the lower of the two prices. Remember, customers get the worst price. Now the bid is 9350. That is the best price a customer could possibly get when selling stock. Now, right away, this investor is asking to sell stock at $93.53. That is above what the DMM is willing to trade for. That's at a better price. Now they can submit this order, but it's not going to be filled in its entirety right away. The market might start trending upward. 00:07:06 That order might eventually be executed, but asking to sell stock at 9353 when the best price available is 9350, that's just not possible currently. Even though they're willing to sell fewer shares than the 600 that are available on the bid side, it doesn't matter. They're asking for a better price than what's currently available. That's probably going to be your answer there. It's the first one we've looked at. But I always stress this, it doesn't matter if the first answer is the right one. We want to keep moving on to confirm that there's not a better answer and really to confirm that our answer seems. 00:07:36 Like it's the best. We should be able to look at the other three here and make sure that, hey, this one can be filled in its entirety. Let's look at that. We'll go to the bottom left, buy 700 shares in 9362. Investors buy at the ask on the right hand side. The Dmm's best price on the ask side is 9360. That is the lowest price they're willing to sell stock at. This investor here wants to buy it at 9362, which is 2 cents higher than their best price. This order can get done now something we. 00:08:06 Also need to confirm is whether or not the order size is appropriate. There are 800 shares available on the ask side. They only want to buy 700 that is less than their maximum. Therefore this order will get executed in its entirety right away. 00:08:21 Let's go to the answer at the top, right. Next, sell 550 shares at 9350 investors sell at the bid, the lower number of the two. We know the bid side is 9350. That's the best price available and that matches exactly what the order is asking for at the same exact price. So that fits into the quote. Now we just need to make sure they're not asking for more shares and what's available. We have 600 available shares on the bid side. They're only asking for 5:50. That order will be executed in its entirety. Last one at the bottom, right? 00:08:51 Buy 800 shares at 9363. Investors buy at the ask payout The ask. The best price to buy the stock on the ask side is 9360. They're willing to buy at 9363, three cents higher than the best price. We only need to make sure they're not asking for more shares. In what's available 800 shares available on the ask side, there are 800 shares they're specifically asking for. Therefore, this order can get done. So that confirms that the first answer we came across the sell 500 shares at 9353 is the only order. 00:09:21 That would not be filled in its entirety. Here's another way to look at it that might help. Remember DMM or our market makers kind of like going to a store of stock and think of that store saying, hey we're willing to buy and sell stock with you. Here are our best prices. The reason why the answer is the answer is because that investor's looking to sell stock at 9353. That is better than the best price out there. On the bid side, the DMM is basically saying, hey, if you want to sell stock to me, best price I can offer is 9350 that. 00:09:51 Investors asking for something that's three cents better than their best offer. Therefore, this order will not be executed immediately.
