The games people play

Celticheart Investor

A beginner's guide to trading and investing

You would imagine that dealing in stocks and shares would be quite straightforward, whether as a trader or an investor. The object being to buy cheaply and sell at a profit, so why is it so unpredictable at times.

The reason is that not everything is in fact what it appears to be at first sight, manipulation is often the name of the game, sometimes subtly and at other times quite blatant.

So who is responsible for this kind of manipulation and is it in fact allowable under FSA rules? Well the second question is probably the easiest to answer so I will deal with that first. Much of which is covered by the "Financial Services and Markets Act 2,000" (FSMA). http://www.fsa.gov.uk/pubs/staff/code_conduct.pdf

One of the catagories defined in the FSMA is the misuse of information where information is not generally available. It is an offence to trade or deal based on that information or in fact to encourage others to do so. This is generally referred to as insider dealing. Worth bearing in mind that where market abuse has deemed to have occured by the FSA they are empowered to enforce an "unlimited" financial penalty, a sobering thought.

In addition to which it can carry a seven year prison term under the Criminal Justice Act 1993 if the FSA feels it a serious enough offence to prosecute.

That of course is the extreme end of manipulation and quite clear cut but let's look at the sorts of manipulation we all come into contact with on a daily basis.

On the London Stock Exchange (LSE) there are official market makers (MMs), these are some of the LSE's member firms that take on the obligation of always providing a buy/sell (bid/ask) price in each of the stocks in which they make markets. Both their bid and ssk prices are displayed on the Stock Exchange Automated Quotation (SEAQ) system and it is they who are responsible for dealing with brokers buying or selling stock on behalf of their clients.

http://en.wikipedia.org/wiki/Market_maker 

Can what they do be seen as market manipulation? We have all been in the situation where a stock is being heavily bought and yet the Bid price stays static or even drops back, particularly when the market first opens. If this is indeed manipulation it is very difficult to prove but Market Makers are on occasion known to deliberately lower prices to panic weaker investors into selling their shares, a practice referred to as "Tree shaking".

Raising the bid price encourages selling, sometimes this is done in a falling market and is referred to as a "Dead cat bounce" with the Market Maker trying to convince buyers into believing the share price has bottomed. The aim of all of this of course is to encourage liquidity as it is by generating trades (buys or sells) that the MMs make their profits.

Dropping the price suddenly can also have the effect of triggering stop losses which is why I generally advocate not using them on volatile stocks but that is something for each individual to decide for themselves.

http://celticheart07investor.blogspot.co.uk/2013/01/stop-loss.html

There is though another far more devious form of manipulation going on that has nothing to do with the official Market Makers, at least not transparently so. These are those individuals and sometimes groups that post on social media and bulletin boards either talking up a share (Ramping) or talking down a share (De-ramping). This practice is widespread and becoming quite a problem at times. So much so that some CEOs have actually taken legal action against those that spread blatant lies about their company.

So what is the motive behind these posts? Well as far as the Rampers are concerned, they are generally holders of a share who want it to rise and will make a concerted effort to convince anyone who will listen that it is going to do so. Whether or not this has any real effect on the market price who knows but it is noticeable that shares do rise rapidly (spike) for not justifiable reason at times given some credence to this practice.

As for the De-rampers well their motive is generally one of two things, they are shorting the stock (taking a short position) or are looking to drop the price for a cheap buy in at a lower level to go long (taking a long position). My advice would be to ignore both Rampers and De-rampers because the one thing you can be certain of is neither have your best interests at heart.

There is of course another significant area where stocks could be seen as being manipulated these days and that is through the medium of the advice columns in our daily newspapers. If a share is tipped or knocked back in these journals then quite often the response is disproportionate. 

The same is true of pundits who go online and tell people to buy or sell stocks often quoting totally unrealistic target prices. The scary thing is that many small investors are influenced by these people, my advice would be to do your own research and treat these articles as just another form of research but certainly not as gospel.

A cautionary note, trading and investing in shares carries a level of risk, these blogs are only meant as a basic guideline to investing and trading, always do your own research and base your decisions on what you can afford to lose. This blog is not intended to provide financial advice as I am not qualified to do so, it is simply designed to provide information about how the markets work that might be of some help to private investors like myself.

Stop Loss

Celticheart Investor

A beginner's guide to trading and investing

Setting a stop loss is one of those things that, at first glance seems like a great idea but when you look into it in  greater depth can be less appealing. So what exactly is a stop loss you might ask?

A stop loss is any order that you place with your broker or automatically online to sell a security when it drops below a pre-set price. The idea is to limit your losses in the event of a sudden drop in price. This is also know as a stop order or a stop-market order but to be honest the term generally used is stop loss.

So what could possibly be wrong with a system designed to reduce your risk of losing money, after all risk reduction is what it is all about? The problem is this, imaging that you stop monitoring your shares for a while whether for a day, a week or a month having set your stop loss at say 15% below the current price.

While you are gone the price drops dramatically for a very short period of time, maybe because of profit taking, bad news or just rumour. Regardless of the reason behind the drop if it falls below your set limit your shares will be sold.

You will have lost 15% of the value of your holding but 85% (less the trading fee) will still be intact, in cash, back in your account. The problem arises if this was little more than a temporary drop caused by sentiment rather than any major catastrophy so the shareprice recovers, possibly even back to the level you left it at or higher.

You return to your holding to find that not only are you 15% down on your investment but  to buy back in will cost you even more, as usually the Ask (buying price) is higher than the Bid (selling price). So what seemed like a good idea has in fact turned out to be a bad thing.

Now I am not saying that stop losses do not work, of course they do, in the event of a sustainable drop in the price you will have limited the damage to your funds possibly even getting the opportunity to buy back in cheaper.

This is where it gets tricky, how do you decide when a stop loss is a good thing or not? I would suggest that, as with much to do with investing (or trading) that there is no simple answer except that the more volatile a share is the more likely it is that you will get spikes and retracements so the more likely you are to trigger your stop losses.

If you ask the more savvy investors they will tell you that it is not uncommon for a share to come under an attack often referred to as a "stop loss raid", where a price is deliberately driven down to trigger stop losses and as a result free up shares which will inevitably then be bought cheaply. Whether or not this is just one of those myths associated with trading or not it is impossible to say and even more impossible to prove, suffice to say it does appear to happen more when a security is in demand.

One way of protecting yourself is to monitor the volatility of a share which many charting packages will allow you to do. If the security is high in volatility then you are probably best to ride the peaks and troughs but if it is low in volatility then a sudden drop could be significant so worthy of setting a stop loss. Ultimately only you can decide the risk level you are prepared to take and whether setting a stop loss is the right course of action for you.

It is probably worth mentioning that stop losses can also work when shorting a security by limiting the price at which the share is bought but the same risk applies with a spike triggering your purchase at a higher price than you wanted to pay. Personally I do not "short" a stock but many do so worth a mention.

A stop loss can of course also be used positively to lock in profits by setting a sell price at a level of profit you are happy with lets say 10%. In a volatile market where spikes are common you might decide that it is worth ensuring you gain some profit rather than miss out on selling on a spike, the danger here of course is that you sell prematurely and miss out on a much bigger profit.

You can of course set what is called a "trailing stop loss" where the stop loss level tracks the current shareprice by a fixed percent for a given period of time making the risk of getting caught out less likely.

Next time:  Communication

A cautionary note, trading and investing in shares carries a level of risk, these blogs are only meant as a basic guideline to investing and trading, always do your own research and base your decisions on what you can afford to lose. This blog is not intended to provide financial advice as I am not qualified to do so, it is simply designed to provide information about how the markets work that might be of some help to private investors like myself.