Sunday, August 30, 2009
Manipulation: myth and reality
Always hot and contradictionary topic, causing emotional flare-ups all over various boards and forums. Since the conclusion some make is that manipulated markets are untradeable, it becomes a matter of practical interest for us. As traders though, we are interested in reality, so let's try and analyze the matter at hand. Also, as traders we want to do it not for the brain exercise but in pursuit of a practical pragmatic purpose - and that's what we are going to arrive at.
Little qualifier before we begin: everything said below is said about normal liquid markets. I am not discussing extremely thin markets where the smallest order can move the market - those are disaster in the making for anyone who wants to play them, manipulation or not. I am talking about those real markets, you know - hundreds of millions of shares available, thousands of players involved.
Second qualifier: everything said below is said as a TRADER - someone who reads the markets and strives to profit from his read. If you prefer to discuss social aspects of this topic - that's for some other blog.
First things first: we need to agree on a definition - so we discuss the same thing. Let's go over some versions and see which ones are realistic and which are not. So, what do we mean when we say "manipulation"?
1. Assigning the price arbitrarily.
Here are couple phrases that you will find familiar; I have no doubt you heard them many times.
"They keep the price down so they and their friends could load up on the cheap".
"They run the price up so they and their friends could unload".
Sounds familiar? Thought so. The premise here is, there is certain entity (THEY) that is capable of making the price whatever they want. Practically assigning a price. Woke up this morning, got yourself a price... How nice for THEM. I have couple questions though.
First: HOW? Really, what is the mechanics of artifically keeping the price low or running it high? Can you just say "stay low" or "run up" and so it will? Or you have to actually SELL in order to keep it artifically low and BUY to run it artificially high? Because if you have to sell, really sell real shares, then what is the point in doing that? If you want to take advantage of the low price you kept low by selling, you will need to buy, right? And that's when you are going to play right in hands of those who bought from you earlier - lifting the lid and switching to buy side, you are going to run the price up now, to the benefit of those who bought from you earlier. If you are lucky, you may break even by buying back your shares at about the same avereage price you sold at earlier. Most likely you won't. Same scenario plays out if our brave manipulator runs the price up by his own buying. He does that for... whose benefit? His own or his friends, right? And just what will he/they have to do in order to take advantage of that inflated price? Why, sell of course. But he is not supporting the price anymore since he turned into a seller. If he run the price up all by himself, it's going to collapse as soon as he withdraws his bid, let alone starts selling. (If you are tempted to say at this point "wait, but his actions could have attracted others so he kind or provoked them and then they did his bidding for him" - good thinking but hold your horses, we will get to it).
So, actual selling or buying in order to get price where manipulator wants it is not really the way to achieve anything but get steamrolled. And, I still have second question. Here it is:
Listen, if government/Fed (entities most often accused of manipulating the markets) really have the ability to just make up any prices - why do we experience these gut-wrenching crashes at all? Those wild fluctuations cost elected officials and public servants their jobs, influence one's historic reputation - why wouldn't THEY just keep markets going up forever and ever? Everyone's happy, everyone's wealthy, some are rich, no mass revolt, no complications, THEY are cheered - what possible reason would THEY have to let it all go down in flames making THEIR life immensely difficult?
There is only one conclusion I can come to here answering "true or false" to this one: FALSE!
If we agree that no entity can simply assign a certain price, let's move to the next possible definition.
2. Manipulating information flow.
THEY present reports and numbers and analysis in a distorted way in order to provoke certain reaction - that's the gist of this accusation. True or false? I don't think anyone in their right mind would deny it's possible and it does take place. The only question I have about this one: what else is new? Name me any society, any civilization, any period in human history where and when it wouldn't be done. Let's be real here: no one should endorse or condone or justify this practice - but there is no reason to consider the markets being untradeable for this reason. How exactly you trade the markets where information is being distorted is another matter, and we did dicuss it earlier, for instance here. As far as traders' point of view goes: there always was, is and, I'll venture to suggest, will be a divergence between what available information says and how the market reacts. You will find confirmations of this phenomena in the books written 100 years ago. Whatever you think about the practice, whatever causes it - by no means it prevents anyone from correct reading the market and profiting from its moves. It happened always and at all levels - Bre-X, anyone? UAUA false news last fall?
Interesting thing about this aspect is, many of those who express their outrage at this kind of practices by government, Fed etc. also claim they they see through the lies and know how things look in reality. I certainly don't claim anything even close to this kind of understanding of these complicated economic issues, but... if what THEY do is so transparent, then it must be possible to exploit, no? I mean if you understand what manipulator is doing, then as a trader thank him and use his manipulation to your benefit. And if you can't - well, either his manipulation is not as transparent as you think (in which case what's with accusations) or your trading skills are not as great (in which case, maybe best to focus on honing those) ?
My conclusion would be: TRUE, but old as the world itself.
3. Government's and Fed's own buying or selling of certain assets.
Sure. Why would anyone try to deny this if they themselves claim they are doing it. The question though is, so what? They pursue certain goals, thei intentions can be analyzed, so how is it different from any other market force? Read the tape and trade accordingly. And, while we are on a subject of definitions, let's call it for what it is: intervention. Because, if you want to call any entry into the market with certain purpose in mind a manipulation, then any single buy or sell, yours included, will be manipulations. Government intrusion, considering that the government is not, or should not be, exactly market moving force can safely be called intervention then.
Conclusion: TRUE, but from a trader's point of view, how is it different from any other market moving forces?
4. Faking intentions so other traders get duped into wrong reactions.
Ahha! Now we are talking my language (those of you who read our trading logs know it as Threeiish). This is where we are going back to that suggestion that manipulation can be done by provoking trading mases to act in a certain way.
There are two aspects to this kind of manipulation. One is what is known as "painting the tape". The term refers to illegal activity in which manipulators buy and sell the stock between themselves. While they remain net neutral, their actions create a false impression of a certain activity. This is clearly and undeniably illegal; if you know for the fact it's taking place on a certain security and have an evidence - simply report it.
Another aspect is actual trades placed by manipulator in the market in attempt to create certain reactions. Our manipulator may try to buy very quietly in order to mask the fact that he is building position - and that's what in fact skillful player will do at the early stages of accumulation. When his accumulation is mostly done, he will try to make his buying more noticeable to attract new crop of buyers by increasing volume and new highs in price. When and if he is successful, other players will come and take the price higher - and he will start distributing his shares to late buyers. And that's how The Game is played. This is readable. This is basics of the method known as Tape Reading. If our manipulator is successful in doing it - more power to him, AS LONG AS IT'S DONE BY HONEST RISK TAKING. Yes, that's my criteria - because what I described means he takes the risk, fair and square. If he is unsuccessful, he will lose money. Can it be that the company goes bankrupt on him while he accumulates shares? Sure, if he didn't do his homework well. Can it be overtaken by another company at the price lower than his average accumulated price? Can the sector turn down before he gets a chance to distribute his shares? Can some new technology come around and benefit a competitor while making the company whose share he accumulated obsolete? See where I am going with this? Unless our hypotetical manipulator acts on illegaly obtained inside knowledge, he takes honest risk - and, most importantly for us trades, in a process of doing so he creates readable opportunity for us. At least for those of us who have the skill to read it - but isn't it the whole point?
Let's make out last conclusion: TRUE, and thank you trading gods for that.
Got other scenarios? Throw them in, let's discuss.