Capital markets continue to experience frenetic volatility; the consensus is that these types of swings in times of uncertainly will continue.

Volatility is caused by a number of factors, both tangible and intangible: domestic investors unable to withstand any more paper losses capitulating and selling in a falling market; foreign investors, concerned about perceived unreliable earnings numbers, taking their money and going home; lack of liquidity in trading caused by cash sitting on the sidelines; and market makers more reluctant than ever to step in and shore up securities with falling valuations.

To understand the role that market makers play in investing activity, very large heavily capitalised investment firms, such as Bear Stearns, Merrill Lynch, Goldman Sachs in the US investment markets, have the economic and legal power on either side of the trading equation to ensure an orderly smooth market.

Simply put, they are actually the middlemen, the unseen force between you, who may wish to sell a stock (bid - the highest price an investor, trader, or dealer is willing to pay for a security), and another party who wishes to buy (ask - the lowest price at which the investor or dealer is willing to sell a security).

Securities here mean stocks, bonds, etc, but no open-ended mutual funds which are bought and redeemed through the mutual fund company.

And in theory, it works like this. The market maker plays and profits from both sides of the fence.

They capitalise on the difference between the bid and ask prices, the spread as it is called.

Say you want to buy a Martha Stewart Living stock for $5 per share, and another investor wants to sell their's for $5.50 a share. Oops, you don't think I should be picking on Martha, sorry, free enterprise system, her company is fair game just like anyone else.

We don't play favourites. The market maker offers to buy the shares from the seller for $5.00 per share, then turns around and tells you that the asking price is $5.50.

You think Martha's shares are going to bounce back, so you say yes. The 50 cent spread in the middle is profit and goes to the market maker.

The role of the market maker is to actually 'make a market', that is when no one wants to buy, they have a mandate to step in, buy, hold the shares in inventory and sell as the valuations come back.

In the old days, meaning only pre-Internet, as all transactions flowed through them, the market makers truly controlled the markets.

And during the Crash of 1987, market makers did step in to rescue falling stocks; several were badly burned and went bankrupt for their efforts.

But in investment markets, things change at the speed of light.

The introduction of electronic trading platforms such as ECN have eliminated much of the market maker's playground by matching buyers and sellers, without the aid of the middleman.

To understand this equation further, every transaction must have a willing seller and a willing buyer who both feel they are receiving fair consideration for their investment. But what if they had a firesale and no one came? No buyers, that is.

That, readers, is precisely what is happening with certain security sales in capital markets today.

Until the buyer of a falling stock feels it has fallen enough to fair value and can be resold at a profit, the share value will oscillate more.

If the electronic platform trading station cannot match a seller and buyer, it goes to the next best thing, the market maker to effect the trade.

Ah, but we have also had another change. Decimalisation! Trades used to be quoted in round numbers and fractions, such as 5 and , or .

Where market makers could make an absolute minimum decent spread of 12.5 cents or more, now price spreads have been driven down to 6.5 pennies, then 3 cents.

Think of the enormous volume of trades a firm has to effect to make a profit a 3 cents a share.

And understand the enormous risk that the market maker shoulders to 'pick up the freefallers' and make a market. What if they can't sell those same shares into a volatile upturn? Increasingly then, market makers are not stepping in immediately, they cannot afford too, thus the liquidity of the market decreases also.

Cash flowing through sales and purchases is what drives markets and economies.

And there has been a third extremely significant change.

In May of 2002, securities futures trading has been introduced to US markets with the creation of OneChicago, which is a Lead Market Maker system responsible for providing continuous, two sided markets and liquidity for all products.

Currently they are implementing single stock futures which are agreements for delivery of shares of a specific stock at a designated date in the future.

And narrow based indices, which are futures contracts on small groups of stocks that allow an investors to take a position in a concentrated area of the equities market.

While in theory having these additional hedging products readily available to most investors should mitigate volatility patterns, it is too early in the game to tell.

Stand by to see how the game is played out.

Next week we offer some hints on how to research investments you own.

We are getting inquiries from individuals who really are not sure what their mutual funds are doing and whether they should keep them or sell them.

Are they bad? Are they good? They don't know, but they do know that they are tired of seeing increasing losses.

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Martha Harris Myron CPA CFP(tm) is a Bermudian, a Certified Financial Planner(tm)(US license) practitioner and Manager, Financial Planning department, Bank of Bermuda. She holds a NASD Series 7 licence, is a former US tax practitioner, and is the winner 2001-The Bermudian Magazine - Best of Bermuda Gold Award for Investment Advice. Confidential Email can be directed to marthamyronnorthrock.bm

The article expresses the opinion of the author alone, and not necessarily that of Bank of Bermuda. Under no circumstances is this advice to be taken as a recommendation to buy or sell investment products or as a promotion for financial plans. The Editor of the Royal Gazette has final right of approval over headlines, content, and length/brevity of article.