I will try to briefly respond to your question about the bid/ask machinations in the market. I am by no means an expert and have simply learned out of necessity to understand basically what is going on sometimes. I will discuss a typical market (part I); and a heavily-shorted one (part II).
If you had level II you would know right away what I have been talking about in past posts because it shows what is really going on in a particular stock's marketplace resulting in the bid/ask you see on the screen (level I). A simple way to explain it is the stock's price is kind of like a see-saw; one seat buy, one seat sell. If the weight is more heavily on the buy side the price goes up, chasing the supply-demand curve up to the notch where the weight is more evenly distributed on the see-saw. The converse happens when the weight is more heavily on the sell side.
Level II actually shows how all the bids and asks are queuing up to each seat on the see-saw, including the id of who (which MM's) are responsible for the weight distribution. As I understand it the bid/ask reported on level I are the sustainable bid and ask prices. That is why on quote.com, for example, they report the bid (sustainable) and the best bid. And also, that's why you can have sales that are outside of the bid/ask range and yet see the bid ask remain the same before during and after that sale. Quote.com is worth watching for awhile to understand what I am talking about. It turns yellow with each sale showing which side of the bid ask the negotiated sale was made. (If you click on the data area it reveals the bid ask info. I talk about.)
In what I call a normally-motivated market it is easier to understand how stock prices are set. I mean basically, in NASDAQ, the several mm's are trying to make a market and are competing for the client buyers/sellers' business. They establish and live off the spread between the buy and the sell. A bigger buyer or seller will try out different MM's and to succeed in keeping their business they need to make sales and buys to keep their customers happy.
NASDAQ relies on the competition between MM's to self-regulate market action. In other words, in a competitive market the different MM's competing for the business will keep each other honest. Apparently there are also rules about their behavior. Thus, on level II you can see the different MM's trying to make a market on a stock, each one's current bid and ask, and also the current demand associated with the position. These guys make sales and purchases back and forth which we commonly see (in level I) as the general market in the stock.
Thus, if several MM's have customers that want to buy the stock; more than want to sell, then they raise their bid price (their want ads) because that will probably get more sell offers by walking up the demand-supply curve. If they have several clients that want to sell, more than want to buy, then they lower their offer (their for sale signs) to interest more buyers. Its a pretty efficient system, and the different MM's negotiate with each other pretty quickly, and can move large volumes of shares as the price moves up and down the supply demand curve.
Now, all the above is more complicated than described above and MM's can establish different spreads, can take out stop-loss orders by moving the price rapidly - particularly in lightly traded markets; and can move the market in the manner and timing of their buys and sells. But I won't get into any more detail; there are plenty of books with all the gory details.
It gets more interesting when the shorting of shares is introduced into the above mix.
When a market is heavily shorted eg.(2.5 M shorted shares in 10M float market), what is "normal" bid/ask behavior gets altered (influenced) by the changed motivations of the trading participants. Now there still may be be numerous (short-covering) buyers, but to get the business they put out lots of "want ads" that show a buying interest but only at a lowering price than what is being offered.
Thus, you will often see a sale at the bid price and then the bid will be lowered, as if the only people wanting to buy this dog are less and less willing to give up good money for it. Sales at the offer price, or at a negotiated in between the bid/offer price become rarer, but when made the bid price is often lowered. This is because the purchaser's (shorter's) primary motivation is to buy shares, yes, but at the lowest price the can get them at.
What also happens is that these "differently-motivated" MM's will have a stockpile of the stock and they will sell these shares to each other (back and forth) at the bid price or lower. In this way they can actually create a falling market, that results in a lowering price, frees up sellers willing to duck out, and of course gets them their covering shares at lower prices.
Eventually, if they dry up the pool of shareholders willing to sell, they allow the price to rise a bit (by staying off the bid for a while) and then lower the boom again (shaking the tree); or simply keep pounding the stock down using the 2 basic techniques above to free up more scared sellers. Of course, if shareholders refused to sell or called in their certificates the short positions would be in deep do-do. But that rarely happens because of the lack of organization among shareholders. (It takes less effort to sell or sit back and blame the company, than to actually do something and try and organize with other investors.)
All the above work best in a lightly-traded market, where there is believable doubt that can be created about the prospects of the underlying company, where good news can be contested, and where big buyers are unlikely to jump in and be a "fly in the ointment" of the above carefully-orchestrated trading activities.
In sum, look for buying at the bid, light trading, the size of the short position, consistent downward price walking behavior, shaking of the tree price behavior, etc.
Credit for post to davewashdc
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