Usual Strategies Used to Pop the Stock MarketBy on 2011 Aug 7 Sun 14:26:55
When the stock market is selling off in panic mode, the authorities would step in.
It is not something new. It is not personal. Things are done in the name of calming or stabalizing the markets. Although these measures may not be effective at all, they will still be executed because it is just how the system works.
Following are common techniques employed to force a market to go into short squeeze for a short period of time.
Short Selling Margin Increase
Why short selling margin increase only? To force overleveraged shorts to cover.
Why it is ineffective? This works only on daytrading short sellers without enough margin to cover their positions for overnight holding.
For those who have longer term shorts, obviously the market has already tanked so much, you cannot force them to liquidate their positions as they are deeply in profit.
Why just doing this on short selling side and not a general margin increase to punish the speculators, so to speak? The weak longs are already leveraged to their neck to say double, triple down on their losing positions, thus any margin increase will focus them to puke. That is not the intention of the authorities.
Outright Ban on Short Selling
Been there. Done that. You’ve all seen how good that works.
It will force a strong short covering rally but will induce a bigger and worse off drop afterwards as we have witnessed across the bank stocks. Unless, of course, the time bought from the short squeeze allows for extra measures to be done to further pop the instruments in question. e.g. changing accounting rules to make those stocks look good.
Index Future Margin Increase
This is done only after a strong bounce already happened. The reason is that the long players who created the bottom will be in an advantage over the last batch of short sellers, as well as the prior long players who picked the bottom a bit earlier, thus putting the last batch of short sellers in red. i.e. late shorts are cornered.
Massive Buying at Particular Index Price Levels to Induce Buy Programs
This is one of the oldest methods to pop the stock market. It was done to stablize the US stock market crash back in 1987 and since then used in various times to create market bottoms, force for powerful upside breakouts, etc.
Executing Buy Program at Specific Index Price Levels to Trigger Massive Short Covering
That is done in coordination with the massive buying of the index future contracts mentioned above.
Once the index future contract is trading higher than its counterpart cash index for certain amount, the premium between the two will be good enough to execute an arb program to buy the stocks and sell the index futures for almost sure profits.
Pull the Plug on Some Well Known Retail Brokerage Connections to the Exchanges
You won’t believe this nor can I. But there are rumors that during various major market flush low days, retail traders are saved from dumping their stocks because they could not execute their sell orders due to technical difficulties.
Feeding Rumors and News Shock
Another classic technique often used by authorities to move the markets. Sometimes spreading the rumor of the authorities is going to act at a specific price level in the index would spook the short sellers to cover before the index drops to the whispered price level. It will also induce people to buy at that price zone speculating that the market will go higher from there.
Sudden Rate Cut
Happened many times over the years. It works in both short terms and in long run as rate cut has huge impact across all areas in an economy.
The problem, however, is that using rate cut with the sole purpose to save a sinking stock market is not only unsound, it is also a waste of money.
There are many more ways to mess with the stock markets.
The main problem will all these tricks that help popping the stock market never addresses the fundamental issues that I outlined in Know Your Odds Before You Trade.
As long as general public are not properly informed about the real risk in holding stocks and other financial instruments as investments to protect the so called financial industry, we will continue to see wild swings in equity markets again and again.
As a trader, the awareness of these tricks will help you prepare yourself to handle the sudden wild swings directly caused by these market intervention profitably.