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January 1, 2005

Bullseye Trading Illiquid Markets

By Gregory Bresiger

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Trading in the Pink Sheets and the OTC Bulletin Board (OTCBB) used to have two speeds - slow and slower. Indeed, Anthony Martinez, senior vice president of trading operations at BrokerageAmerica, a market maker in OTC securities, says it was a constant headache. "You had to call around on the phone to find the quotes," he remembers, "and then you had to write them down on a ticket."

The OTC and the Pink Sheets were once ignored by many professional traders. Now, "they're crackling with activity. These markets have become exciting and invigorating," says Nick Ponzio, president & CEO of Hill, Thompson, Magid, & Co., a Jersey City-based market maker in OTC and listed securities.

Ponzio says activity in the Pink Sheets and the OTC Bulletin Board often foreshadows strong performance in other marketplaces. "You see things jumping in the energy field or the small-caps, then you'll often see the same happening later in the large exchanges," he explains. "The Bulletin Board and the Pink Sheets often act as incubators."

So Ponzio says his firm isn't simply betting on individual stocks. Instead it is looking at these two sometimes maligned marketplaces for hints on what sectors are about to turn around.

Until recently, the OTC marketplace was extremely mechanical. For sophisticated traders, this was a sore spot.

Today, the market for these unlisted equities has made huge technical advances. And that has attracted the notice of the big boys. Mutual funds are helping to overcome the problem of these kinds of stocks. Pink Sheet and Bulletin Board entries generally have been thinly-traded and widely misunderstood. Nevertheless, they get around. These illiquid stocks have also been known to show up in mainstream markets such as Nasdaq and the New York Stock Exchange.

Trading on the Bulletin Board and Pink Sheets is contributing to the bottom line at some of the largest dealers on Wall Street. For example, Knight Trading Group reported a 60 percent increase in Bulletin Board volume in October.

"For truly illiquid stocks, the demand for commitment of capital - for actual market-making services - tends to be high," says Ian Domowitz, managing director of Investment Technology Group, which operates the POSIT crossing network.

Still, demand for these risky vehicles is one thing, an understanding of how they work is another. Traders need to appreciate the precarious business of trading in the largely unregulated markets of the Pink Sheets and Bulletin Board. "There's a great degree of risk trading these kinds of names," Ponzio says, "but the rewards can be great."

And for many of those hardy traders who negotiate the netherworld of illiquidity, there's no substitute for the personal touch. "It's a relationship business," says Jack Norberg, chairman of Standard Investment Chartered, a Costa Mesa, CA-based money manager that specializes in closely held, thinly-traded equities. "We don't have high-end electronic trading systems. You've still got to press the flesh." Norberg attends annual shareholder meetings and buys shares directly, in private transactions, and typically holds them until management repurchases them. To Norberg, his unlisted stocks are like "rare coins, antique cars, exceptional paintings and other collectibles."

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