December 21, 2011

Bear Raid

There's some speculation that the latest stock market crash was the result of a "Bear raid".  That is, a bunch of either investors or traders colluded to crash a particular stock.  They do this by taking short positions. (Selling borrowed stock that they hope will fall in value before margin call which allows them to keep the difference in value from the initial price.)  This is a very risky proposition.  If the stock does not fall and in fact, increases, you must make up the difference in value.  For example, if ABC corp. stock is valued at $100 when you take a short position and it is valued at $90 by margin call (closing bell) you have made $10.  If the value at the close is $110 you now owe $10.  

To make real money on this type of deal bear raiders will either try to leverage negative information about a company (missing earnings targets) before the information is public.  They can also leak negative information (whether true or untrue) to try and make the value drop.  Once the drop starts, the other players take huge short positions which triggers other traders to get out of their current positions in the stock to prevent further loss.  This is also amplified by the trading programs which have triggers built in to dump stocks based on market conditions.  That is, the software used by a bank or trading company has logic built in that if ABC corp. goes below $89, sell all shares as fast as possible.   Those two things combined could conceivably make a stock tank in very short order.  The really brave bear raiders will then wait until the stock bottoms out and take long positions expecting the value to rebound.  (Imagine the $100 stock falling to $25 which they then buy and when it goes back up to $50 they'll sell again.  That way they make money on the negative slide and the recovery.)

This is all illegal and just the type of thing the SEC is supposed to be investigating.   The attached document is interesting and appears to me to be statistically correct but the attempt to link this to either a bear raid or the lack of an uptick rule is reaching.  Market behavior is certainly changing as data models, risk models and automated trading are getting ever more complicated.  (I was going to say sophisticated but that's assuming there's elegance involved and that I can't say for certain)   The speed of trades is also causing distortions.  Look at the virtual death of currency arbitrage markets.  The speed of trades is so fast now that you need to execute trillions of trades to make any money.  The margins just aren't there.  The upside to that speed is the relative stability of prices is achieved very quickly if not painlessly.  

The SEC has a monumental task.  Some think it has an impossible task.  Mabye.  That doesn't mean they shouldn't exist.  They should be more oriented toward fraud investigations and market making than filling out forms and ticking of boxes.  


Posted by Duffy at December 21, 2011 03:29 PM | TrackBack

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Thanks for posting this... I've been telling you this for years... that the markets (and fuel hedge funds) are not free trade... They are manipulated... Which doesn't mean they can't be free again... All it will take is someone looking over shoulders with proper authority to put wrong enactors into jail....

Which is why Wall Street reform is necessary... Some like Michelle Bachmann don't get it.

Posted by: kavips at December 22, 2011 01:16 AM