Nerds on Wall Street: Math, Machines, and Wired Markets

10.4. Counting Messages

In 1999, John was running Bear Wagner, one of the largest specialist firms on the NYSE, with a good dose of NASDAQ market making thrown in. Recall that specialists (at the time) had a central role as the buyer to nearly all sellers, and the seller to nearly all buyers. They made their living by continuously posting a two-sided quote (see the discussion of market making in Chapter 2), and in normal markets, they would buy low, at the bid, and sell high, at the ask. Keeping the spread small and the sizes large made for a liquid market and large profits for the specialists. The safest strategy for a specialist (or market maker) is to adjust the prices to keep their inventory (net long or short position in a stock) as close to zero as possible, to stay flat so as to never be left holding the bag when there was a sudden large price move in the stock. But that would conflict with maximizing volume to accommodate temporary imbalances between the flow of buyers and sellers. If a specialist or market maker had a way of anticipating which stocks might have that kind of volatility, he could "roll into a ball" and stay flat in those names, while keeping the buy low/sell high process in high gear on the others.

This is why John Mulheren was counting messages on stock message boards. His unmatched market sense told him that if there was a huge spike in overnight message traffic about a stock, it was a good bet that something volatile might happen the next trading day, ...