Broad Oak: your emotional support animal

Friday, October 23, 2009

Are the markets being manipulated?

I'm partway through a 1990s American TV programme (htp: Jesse) about the lead-up to, and aftermath of the Great Crash of 1929. At that time, share price manipulation was legal, everyone knew it went on and even the losers came back for more, hoping they would get out in time the next time round. And in the 1920s, buying on margin became possible, so that provided a fatal extra impetus.

You know all this, of course.

My question (and pardon my ignorance) is about the interaction of derivatives and stock trading today. A takes a huge bet with B that the share price of Widgetco will go down - what stops B from borrowing more cash, purchasing Widgetco in time to boost the price before the date of the bet, collects the cash from A and then sells his firm's holding in Widgetco? Even if now illegal (and I'm not sure of that), are there not ways and means?

And are there other tricks to catch the operator who goes long on a share, instead?

9 comments:

Nick Drew said...

Unless B hedged his side of the bet, he's already gone long the Widgetco share price by entering the bet in the first place. This (ex hypothesi) would be pure speculation on his part, with all the attendant risks; and may be a part of his strategy to go even longer (because he really believes its price will go up, just as A thinks it will go down), which involves B buying up even more anyway. It's called investing in Widgetco !

Presumably, in so doing he has dealt with lots of other people betting the other way, in addition to A.

it's entirely symmetrical - why wouldn't you describe all these sellers as 'trying to drive the price down' ?

Of course, if B buys enough, in certain devious ways, he might move the market price but hey, if he buys enough he's obliged to bid for the whole company anyway. (There are already laws against him buying in a 'concert party', e.g.)

Sackerson said...

Thanks for your expertise, Nick. And I understand that there might be Chinese walls, laws etc - but I also understand that fortunes have been made in circumventing them.

But isn't it cheaper to bet on price movements than to trade in shares?

And isn't there a procedure known as (I heard a trader use the phrase years ago) "roasting a teddy", where on learning that someone has taken a side bet on a share, you then manipulate the price by buying or selling until he runs out of cash?

Nick Drew said...

fortunes made, oh yes - and in bank-robbery too !

cheaper to bet on price movements than to trade in shares?

can be; lower transaction costs, & less tax in some jurisdictions: but it has a different risk profile

with actual stocks & shares (and a secure custodian for your certificates) your risks are (a) the price, of course and (b) that there will be a liquid market for the shares on the day you want to sell (a rather academic risk in some cases)

with betting on the price, your risks are (a) price, as before and (b) the credit-standing of your counterparty - like an insurance company, you need him to be there with cash in hand the day you want to be paid

(same with most derivatives, ETFs, 'paper gold' etc etc)

"roasting a teddy" - same is true for anyone who has taken a position, be it an unhedged bet or actual shares etc - they are exposed to market-price movements, be they 'random' or as the result of (more or less legal) market manipulation or other distortions

but how likely ? you may need to buy/sell one helluva lot to move the price significantly - and don't forget, that exposes you in turn (and not just to prosecution)

it is a fact that very large positions are vulnerable to malicious actions - because they will have stop-losses or margin calls etc that can catch up with them suddenly, on a small movement. Anticipating this, other players will know (e.g.) that this may force them to exit the position hastily, with known consequences ...

[e.g. A is very short, hence very nervous about the slightest upwards price movement; hence likely to need to buy in large quantities when a certain threshold is reached; hence it might be clever for B (who may come to know about A's position in any number of different ways ...) to guess where that might be, and buy ahead of this, both giving the price a nudge in that direction, and possibly being the beneficiary of the further price-movement resulting from when A comes into the market in a big way, in a hurry, to close out his position ... (vide LTCM} - this is simply vulturism and may not involve any illegality]

Sackerson said...

Muchas gracias, Nick.

Sackerson said...

P.S. So the traders do play games, then - it's not about the merits of the shares and the companies.

Anonymous said...

Sackerson: "it's not about the merits of the shares and the companies."

Is it worth remembering that once a stock has been sold, the vendor company cares not a fig about the stock, other than when it pays the divi, or if an undesirable buys too many of them?

Sackerson said...

Good point, Anon. Maybe the future is with privately-owned companies. Didn't Alan Sugar buy his shares back to get control again?

Paddington said...
This comment has been removed by the author.
Paddington said...

I am more and more convinced that all of this money doesn't exist. Bankers take in $1, print $20, and keep $3 of it. What have they actually done?