A Remedy for Short Selling Manipulation

There has been a ton of discussion over the years on the subject of short-selling manipulation in the stock market.

I've heard and read many opinions on this very serious matter, but there is, in fact, a sure-fire way to combat the problem, a cure that I have not yet seen discussed anywhere.

First off, this article is not, per se, about naked shorting, which in itself is a staggering problem and, I suspect, still highly rampant in the market place, even with the SEC's recently announced efforts to go after said illegal shorters.

This article, rather, tackles the issue involving a tactic that short-sellers use to pummel the price of a stock lower, which creates panic in long-position holders, and, in fact, convinces anyone interested in buying the stock to simply wait for a lower stock price to enter. Why would any rational "potential-long" buy higher in the face of a short-raid, if he or she can simply wait for the stock to first be pummeled- and THEN buy long.

I have heard a lot of talk about how killing the uptick rule was devastating for stocks, but, in reality- this was only part of the problem.

The real problem is that shorts love to "pin the bid," which is a manipulative technique whereby short-sellers don't first wait for a buyer to come to them at a higher level, say on the ask price, but, instead, they short directly on the bid price repeatedly (called "pinning") until the bid finally "caves in."

Shorts have learned that if they "tag-team" the bid in this manner, it will, undoubtedly, cave, and the resulting bid will be pushed lower, and then lower and then lower still. With the ask price lowering in tandem with a dropping bid price, exacerbated by other shorts on the ask going lower, longs now start to panic and lower their sell (ask) price even further. Many longs then start selling on the bid itself, and, eventually, the bid is also taken lower and lower as longs panic further, and potential buyers lower their bids in trying to buy as low as possible.

Obviously, shorts don't first speak with each other in coordinating a pin-attack, but, in stocks where there is a lot of short interest, and there are (were) many, it doesn't take much for certain shorts, whether fund traders or wealthier individual traders to initiate the pin process, and for other shorts to immediately recognize the attack under way, and then pile in.

One important additional component of the pin-the-bid technique is for shorts to first "load up" at as high as price as possible, then use additional funds available to them to then force the stock lower. In other words, these shorts make money off their "higher-priced" short positions, and then make additional money in relentlessly driving the stock lower.

The key to the latter is that once a pin attack is launched, as I said, long-position sellers panic PLUS those who are looking to buy long will lower their bids to ultimately buy long as low as possible. These two resultant "panic plus bottom-fishing" motives by longs snowballs the bid-pin/downward short manipulation process. In effect: the shorts manipulating the bid downward rely on their technique to cause the snowball, thereby the shorts don't have to do much work (or spend much money during the pin) to cause the stock to sink a lot lower than it normally would have.

And, then, of course, once shorts have made enough money, they begin to cover buy and take their profits.

So, what can be done to solve this problem, which, I believe is rampant in the market?

Simple:

1. Don't ban short-selling as you need short-selling to create a liquid trading market.
2. Don't just re-instate the "up-tick" rule.

Instead, do not allow shorting on the bid. Period.

I'll say it again. Do not allow shorting on the bid. Longs could sell on the bid. Shorts could cover buy on the bid. But shorts couldn't short on the bid.

It's simple. And it will resolve a ton of issues that relate to downward manipulation of the market.

Logically, if short-sellers wanted to operate ethically, they would not have a problem with this. Why? Because if a short-seller truly (and ethically) wants to maximize profit on a trade, he would want to place his short at as high a price as possible and then cover-buy as low as possible. Why pin the bid when you can short at the ask or higher?

Indeed, if shorts were operating ethically, they'd want the longs to come up to them, and then rely on legitimate market forces at work, such as negative news, to fuel any sell-off.

But, since shorts rely heavily on tag-teaming a stock lower, which they could not do if they were not allowed to attack the bid, I am certain shorts would object to my simple proposal.

I would highly recommend that the SEC, Congress, and companies lobbying Congress against short-selling, such as Citigroup (C), strongly consider implementing this change. It will not result in stock prices being "higher than they should be," but it would allow for stocks to not be crushed without reason.

As for naked shorting, interestingly enough, such naked "phantom" shares might then, very well, be exposed by surveillance bots as the only short-sells that show up on the bid, as legitimate ones would be prevented from doing so at their source.

Thus, such naked bids could be isolated and dealt with immediately by enforcement.

You see, most members of the SEC, Congress and company executives don't trade, so they don't sit there looking at Level 2 on any given day watching this manipulation in real-time. It's so easy to spot.

Perhaps someone should be invited to Congress and set up a giant real-time trading screen for House members during market hours so they can be shown what goes on in the very stock market they say they want to fix and support. Then, bailout dollars-to-donuts- they'll have it fixed before you can say "Don't pin that bid, short fella."

Hope you all have Very Happy Holidays, even you shorts. Try not to tag-team the Turkey will ya?

Comments

[maelstrom:]

Tell us your long possitions...ha ha..Great article great idea

2008 Dec 04 08:49 AM

[DegreeNodal:]

What you are advocating is the original uptick rule as it was applied on NYSE. OTC stocks worked a little different. You had to have your offer to sell taken out, but you could do so without it being higher than the last print. Except for ARCA, which was a separate exchange prior to merger.

2008 Dec 04 08:51 AM

[raytayzmd:]

...I don't believe anyone, anywhere has ever provided hard evidence to prove allegations that short selling has any impact one way or another...until someone collects the data that ascertains the real impact of shorting on prices, it doesn't make much sense to pass laws one way or another.

2008 Dec 04 09:01 AM

[Robert Radano:]

I have mentioned this point before, and I throw out to this readership in hopes someone will either back me, or tell me what i'm missing...

All these uptick ideas are not the answer for two reasons. First, the known issue of ETF's and their role in short selling. Second, and perhaps more basic, the reason shorts can pin the bid so easily is because the most liquid stocks, (those with stock available to short,) trade with a penny bid. In a penny bid what's an uptick? Also, if I'm a marketmaker, old school or electronic, how much captial am I willing to risk on a penny bid?

Again, chime in and let me know, but if spreds were five cents would we not have more stabilization of price? Would it not be much simpler to define the bid and asked price?

2008 Dec 04 09:14 AM

[Alex Trias:]

Great article. The author raises a very fundamental issue: the main problem confronting how the government regulates the capital markets is that the regulators aren't traders. They haven't spent time at a trading desk, and most traders worth their salt aren't all that incentivized to do a stint at the S.E.C. and take a 2000% salary cut.

This article suggests a straightforward way to regulate the markets in terms of bid pinning. I'm going to suggest taking it one step further. If you are a trader who has already made a killing on the market and knows how it works, and you spot a problem, don't write about how to fix it. Get a job within the S.E.C. and do it. Take the pay cut, and chalk it up to public service. If you can't, then take your idea, paste it into a letter to any Senator on the Finance Committee. I'd start with Max Baucus and Chuck Grassley. Follow up with phone calls to their offices and speak with one of their aides.

2008 Dec 04 09:45 AM

[Responsibility:]

I perceive that there must be some improper schemes going on in the market that has been trashed so much, but I am not sure I understand this explanation completely. Is it same as putting a limit order to buy at a much (say 5-10%) lower price than the market price? Can some one explain this in a plain words? Thanks.

Yes, the stock market schemes have become too complicate, inducive to deception. Too much regulations are better/saver than too few, like traffic safety.

2008 Dec 04 10:27 AM

[Smarty_Pants:]

"One important additional component of the pin-the-bid technique is for shorts to first "load up" at as high as price as possible"


So the first thing that abusive short sellers do is to raise the price so they can 'load up' before they drive it down?

I don't think so. It is my humble opinion that the author hasn't thought his position through very much.

Check the actual numbers on short interest in any blue chip stock and you will find that the volume of short selling is TINY compared to total volume. Typically 1% to 2% of total volume in a given time period and a significant fraction of that short interest is generated from option market makers hedging new options positions.

If the author is proposing that a swing of 2% of volume to the bid will move a DJIA stock enough to make a difference then I am agog at his lack of understanding. That's like saying moving from 49% selling volume to 51% selling volume will cause the stock to tank. Hardly.

Mutual funds routinely buy huge blocks of stock far in excess of the volume of short selling, but nobody is claiming that they are 'driving' the prices too high, and in fact they aren't. Even that much volume doesn't drive the market very far for very long.

If the entire 2% short volume hit the bid simultaneously it wouldn't move most issues more than a point. Hardly enough to start the 'stampede' that the author claims would result, and certainly not enough to generate any serious profits.

Market manipulation via short selling is a red herring. IMHO. The volumes are far too small to be a factor in large cap stocks. Any prolonged decline in stock prices results from massive volumes of selling longs due most likely to changing information regarding the stock.

2008 Dec 04 12:05 PM

[Did U Think...:]

Look, shorting is a small fraction of the markets. They can move a stock here or there but not the whole market. Stocks are going down because longs are bailing. Go make up some rules that stop them from selling - perhaps a government mandated floor on the Dow and S+P or something. India did it so why not the Dow? We are getting to look more and more like a 3rd world country everyday anyway.

Yes, let's all make up some more rules, shall we, when we instead should be getting the gov't the hell out of the business of running (ruining) the economy. Just go back to hard currency (honest money) and ALL the problems sort themselves out in short order. Sorry if pain has to go with that but there is no other way.

2008 Dec 05 09:23 AM

[boxerconan:]

Thanks....great article.
Please send your opinion to Obama Transition Team...
I think they are working on SEC restructuring now.
They have to announce the replacement of Cox as soon as possible.

2008 Dec 05 10:30 AM

[Manifestor:]

On the money. Great article. I too see this all the time when I watch the Level 2, in particular around the time a news/analyst report/earnings for the company is released.

Those who don't agree, I tend to believe are fully aware of this scheme, perhaps using this to their personal benefit and don't want it to be taken away. I second the idea of sending this to the Obama Transition Team.

2008 Dec 05 11:39 AM

[James Wilson:]

The Shorts also know that once the reach that magic number of 25 points or 28 points lower the Trailing Stops will kick in and force the price even lower !

2008 Dec 08 02:50 AM

[James Wilson:]

How about the Shorts postng a bond equal to the amount the sell short and stop the borrowing of stock !


On Dec 04 08:51 AM degreenodal wrote:

> What you are advocating is the original uptick rule as it was applied
> on NYSE. OTC stocks worked a little different. You had to have your
> offer to sell taken out, but you could do so without it being higher
> than the last print. Except for ARCA, which was a separate exchange
> prior to merger.
>

2008 Dec 08 02:52 AM

[James Wilson:]

The SEC can't do much since Bush cut thier budget for enforcement !

2008 Dec 08 02:55 AM

[James Wilson:]

They do tag team! The up tick is a problem too. that = a 3rd person to buy 1 share at the ask constantly while 2 or more short the bid.

Stop the naked shorts and the borrowing. Make the shorts own the stock and sell from a covered position. This covering of 1 million shares , like last they did on DRYS on Dec.8, afterhours is nuts.

I want to borrow 1 million shares to sell at the top of the markets and then use to buy back in after the pull back then sell again on the run.. Give me 3 days with a borrowed 1 million shares and I can retire very rich.

2008 Dec 11 04:35 AM

[briacal:]

Thank you for your excellent presentation.I have been involved with the market for sometime and I was not aware of the many hidden traps that are involved in making the value of a stock go up and down beside the intrinsic value of the stock at a given time. Your presentation makes me believe that further regulations are needed to prevent various "teams"to manipulate a stock as they please.Thank you again and best wishes for the Holidays.

2008 Dec 11 05:53 AM

[James Wilson:]

Look at the Short interest on EGLE shipping. Over 5 million shares with 3.2 days to cover thier short sells.

No one gives us 3.2 days free of anything for free !!!!!

Espically 5.6 million shares at $7.20 = $ 40,320,000 free of interest for 3.2 days. This does not make sense.

Heck most Credit Cards operate on a 22 DAY BILLING PERIOD. That is equal to 16.6 months in 1 year and interest due daily.

2008 Dec 11 06:33 AM

[meg:]

Amen!!!! Great article, Hope someone who can do this STOP the bid, save good companies from these people

2008 Dec 11 08:21 AM

[dandyapple:]

Good Article! This SEC Chairman is not interested in fixing this problem, He created the problem to allow the Hedgefunds toa make more $$$.

We need to stabilize the market now, since like it ir not, the Stock Market numbers are how the average person perceives the countries economy. We need to create confidence. Ban all Short Selling for 6 months. Fix the rules during the ban, so the crooks are not running the show when the ban is lifted. It would do more in the short term to help stabilize the economy than anything else we could do. And by the way, fire Chris Cox!

2008 Dec 11 12:26 PM

[Srdjan Popovic:]

There is a theory put forward over 100 years ago that bear raids by themselves can't force the price down as the insiders and others with knowledge about the company would be more than happy to buy at lower prices and by doing so push them back up. Those who get in trouble are the technical speculators caught between two trends, but so be it. The buyers might decide to wait for a better entry, but they won't wait forever... if the company is any good, of course. However, when you have a lousy company or weak economic conditions, it is all too easy to blame it all on short-sellers.

2008 Dec 11 02:41 PM

[Carousel:]

There's also a quote that says, "The market can remain irrational longer than you stay solvent.


Great article GT! I hope it gets implemented!


On Dec 11 02:41 PM Srdjan Popovic wrote:

> There is a theory put forward over 100 years ago that bear raids
> by themselves can't force the price down as the insiders and others
> with knowledge about the company would be more than happy to buy
> at lower prices and by doing so push them back up. Those who get
> in trouble are the technical speculators caught between two trends,
> but so be it. The buyers might decide to wait for a better entry,
> but they won't wait forever... if the company is any good, of course.
> However, when you have a lousy company or weak economic conditions,
> it is all too easy to blame it all on short-sellers.

Apr 19 01:04 PM