Watch out for Dalal Street’s latest pump and dump schemes
Dalal Street, in Mumbai, is the Indian Wall Street. And Mumbai(erstwhile Bombai) is the financial hub that is home to India’s biggest corporate houses, banks, and financial elites. Among them is the financial web comprising of quant shops, hedge funds, brokers, dealers, and small-ticket trading houses.
The securities market regulator, Securities and Exchange Board of India(SEBI) has done a commendable in improving public trust and confidence in the capital markets. Not only launching campaigns for investor awareness, but SEBI has also done a tremendous job of curtailing unfair, fraudulent and coercive practices of large traders who eternally have an upper hand in terms of capital and resources vis-a-vis retail traders.
Ethicality has always taken precedence in Dalal Street. But again, ethics are subjective. On one hand, we have high-frequency traders and their supporters, both inside the government and in corporations, who believe it is ethical for HFTs to get an upper hand than all other market participants including retail traders. Being a staunch capitalist at heart, I totally agree with that for a variety of reasons. Front-running is a common case scenario is every business and in every sector. More importantly, if an organization has invested enormous amounts of money in human resources and technology and takes on significant risk, then it should be compensated accordingly. But this belief might be contradictory to the ethics of some people who present that their return comes at the cost of small traders and it makes the market more volatile and denies them of a level playing field. These, essentially, are the two sides of the same coin, no one can seem to balance them nor can eliminate either one of them. So we have to learn to live and work in co-existence and realize all the pitfalls and the merits of both sides.
Originally, this is how traders used to lure innocent and naive retail investors. Traditionally done through cold calling, the brokers would cold-call investors and pressurize them into buying these stocks. They would also use strategies where they would leave a message on the answering machine with misleading information regarding the stock. This made it look like it was missed call with the information not intended for the receiver. This scheme then moved onto emails and currently even makes use of social media. Now, it’s a network of big institutions that target micro-cap stocks, with low public float and priced at less than Rs.100. Coordinated actions of buying and selling like a cartel have given rise to a new style of pump and dump. Stocks that match these characteristics are bought in large quantities every day for a given number of days. In the pre-open market, large buy/sell orders are placed and when the market opens, the stock has nowhere to go, but up. Thanks to circuit breakers installed by exchanges after the 2008 financial fiasco, stocks open straight 5% gap-up/gap-down and no trading takes place throughout the day. This goes on for a considerable number of days until these penny stocks come into either public or the regulator’s limelight, which acts as a signal for them to exit their trade. Approximately 5000 companies are listed on the Bombay Stock Exchange, so think about all the sea of opportunities that exist for these big fishes to catch hold of small and self-effacing prey.
Take a look at what the graph of a stock, victimized by pump and dump strategies looks like over a period of time. However, there is no fixed time period
As you can decipher from the above graphs, there is no defined time frame of how long should a trade last. Well-seasoned investors are aware to keep away from such penny stocks and know about the manipulation that goes on in stocks like these but many new entrants and retail traders, unaware and naive fall in this trap.
Though unethical, such activities are completely legal. There’s nothing the capital market’s watchdog can do to prevent such activities. However, being a zero-sum game, the big players, using their capital clout, make money at the cost of small, uninformed traders, and ultimately the latter are the ones who lose their money. This demands a regulation from SEBI to stop such unscrupulous activities.
