Friday, July 15, 2011

Link and Copy of Article from MoneyWeek

How you can avoid a Beating from these Thugs by Bengt Saelensminde


"Blaaaadyhell..." excuse me because I don't usually swear, but it was the only thing I could say:  "Blaaaadyhell!!"

I had just received a massive blow to back of the head and four very ugly men were standing over me, shaking their fists in my face.

‘Geldt... maaney - give, give' they demanded. But then, what a surprise...

I would have thought I'd be putty in the hands of a guy wielding a 3ft timber plank. But I was wrong - what actually came out was a belligerent wry smile...  That event happened some 15 years ago. Me and a mate had decided to bike it to Istanbul and we found ourselves on a deserted road alongside the Danube.

It was one of those moments when you surprise yourself. And there is a great deal to be learned from these situations - especially when you are investing. After all, we get roughed up all the time in the stock market.  Today I want to talk about how you can avoid becoming the victim of these beatings. What you need is a little bit of belligerence. That attitude served me well 15 years ago - the thugs didn't get away with anything worth having.  And it can help protect you against the constant threat of thuggery in the stock market too. Let me explain what I mean.

Market makers rough us up every day.

Market makers have a crucial role to play in the stock market. Without these banks and brokers offering to take your buy and sell orders, the stock market would just dry up. Ok you could probably buy and sell large cap stocks. But with small cap and illiquid stocks, you could be a long time waiting.

Market makers rule the roost. They are like the traders in a fruit and veg market - they offer a price to the stock exchange - and these prices aren't necessarily determined by pure demand and supply. By keeping the market liquid, they contribute to a more fair and open system.  But market makers have a dark side. And given the chance, they'll do their best to exploit private investors.  When you go to them, they will either be trying to get hold of stock or dumping stock. And they're not going to let you know which way their order book is lined up. MMs will send out fake price actions and they're designed to mug you of your property...

And when they want to get hold of some stock, they are not above resorting to a bit of ‘tree shaking' - especially after a decent run-up in the share price. MMs move the price down. And panicky investors will get scared and sell their shares.

Have you ever been tempted to sell your shares as you see the price start to drift after a decent run up? Of course you have. You'll have read that a stock has come off due to profit taking. But often it turns out not to be the case. What's actually happened is that the MMs have moved the price down to try to induce some profit taking.

And of course the MMs can play this game going the other way when they're trying to dump stock. It's known as a dead cat bounce. In this case it happens after a share has taken a big fall. MMs may move the price up to make it look like the rout has finished. But if the MMs still have large sell orders to fill then the price is going to head back south pretty soon. The aim here is to skin a few bottom fishers. Let the mugs mop up a few shares and then move the price back down again.

How do you know when this is happening to you? Well there are a couple of ways to recognise the work of a market maker...

Two things to look out for.

The first thing to be aware of is a sudden turn in the price after a run-up, or run-down. Beware of the fake inflexion point. Stocks never move up, or down in a straight line - and market markers are one of the main reasons why. The thing to keep in mind is the overall direction - is the stock in a long-term bull, or bear market? Stick with the game-plan.

MMs make money out of churning stock. They want action - if they're sitting at their desk twiddling their thumbs, then they're not earning any commissions. So they may simply want to stir things up a little. So the second thing to watch out for are price moves without volume.

You can get volume (the number of shares traded) data from many websites including the stock exchange. Download a chart with the shareprice and traded volumes - price moves without volume are suspicious. But beware, often large trades aren't published until after the event (there are specific rules on this), so it may take a day before the story becomes clear.

When confronted with MM manipulation our job is to ignore them. Just give them a belligerent wry smile and say to yourself ‘I know what you're up to' - I'm sticking to my guns.

These days with trading by the click of a mouse, it's easy to let your emotions lead you into quick and costly mistakes. When the markets give you a metaphorical whack on the head, you need to do the right thing. And when emotions are running high, it's difficult to predict what you're going to do...

The key is to have a game plan. Try to map out in your mind what to do when the MMs start with their fun and games. Belligerence is often the best policy.