Steps to getting rich: 1. Short-sell a company. 2. Trash-talk it. 3. Profit.
A recent article in the New York Times illustrates how you can legally pump and dump a company. You may recall a teenager got into trouble with the SEC a few years back hyping penny stocks. He would blast-SPAM e-mails hyping a stock he bought the week before for a few cents per share. The stock would double or triple in value overnight, and the kid would cash out and make hundreds of thousands of dollars. When the SEC fined him, he laughed and wrote them a check.
Technically pump-and-dump is illegal. But others have taken a different tack - they short-sell a stock and then allege fraud or other malfeasance by the company in order to depress the stock price. A fellow tried this with MLM marketing scheme company Herbalife a few years back - but lost his shirt. The Times article cited above describes how another fellow makes millions at this - not by running a hedge fund, but by placing personal bets on companies than then running them down in the media.
Is this fair? Is this legal? As far as the latter is concerned, yes, apparently. You can buy stock in a company or buy a future (short or long) and then raise issues about the company which may direct the stock price in a direction that profits you personally. So long as you are not lying about the company (the error the New Jersey teen made) you are set.
So when some "financial analyst" on the television tells you a stock is going up or down, is he being paid to say this, or does he profit when you and a million other viewers trade in response to his advice? Think about this.
What is disturbing to me is that the New York Times characterizes this guy in their article as some sort of Robin Hood hero who steals from the rich and gives... to himself. They seem to be arguing that as a freelance vigilante he is helping to police the financial markets where the SEC and other government agencies fail. In other words a free-market solution to the problems of the free market. Something even Republicans could love!
And maybe this is true, I don't know. But it made me realize is that these guest speakers on the financial channels are often pushing a particular narrative which they profit from personally. And yet so many people have their eyes glued to CNBC on the television or subscribe to various financial websites which promote or disparage various investments. And people don't bother to ask themselves why someone would offer this free advice as to what to invest in or what to sell.
Again, is the goose that laid the golden egg theory. If you really knew which stocks are going to go up and down, why would you bother telling other people? You would be investing in these stocks or other financial instruments yourself and reaping the profits. If there is a get-rich-quick scheme or Goose that laid the golden egg, you wouldn't sell it to anybody else or much less give it away. Yet for some reason, the average consumer fails to consider this or even contemplate it.
But the second question of course is "Is this a good way to make money?" If you know about some sort of fraud or irregularity in a company, you could short the stock and announce to the world what you have discovered and watch the stock price tank and make a nice profit. And indeed, many people send anonymous tips to folks like Mr. Left (profiled in the NYT article) in order to move a stock price in certain direction, or so they hope.
The problem with this model of investing is that it involves a substantial amount of risk. If you short a stock and the price does not go down, you might end up in a lot of trouble and in fact end up bankrupt. As the Herbalife example illustrates, you can bet it all on this strategy and lose. It is that pesky time machine conundrum which is a reality for us small investors. Since unlike Mr. Left, we cannot control the market with a single Tweet, we are forced to invest the old-fashioned way, diversifying our portfolio and investing in sound things rather than hyped things.
What is interesting to me is that the stocks that Mr Left is shorting are often the same stocks that other people on Wall Street are hyping and thus are very overvalued. In other words, it is the get-rich-quick small investors who drive up these stock prices in the first place - Mr Left is nearly popping that balloon by pointing out the idiocy of these investments.
Still others might read this article in the New York Times and argue that it is evidence that the entire system is fixed. Hedge fund managers and financial commentators hype up a stock price and artificially inflate its value while corporate insiders commit various minor and major forms of fraud or financial bookkeeping irregularities. Then, activist inventors deflate these stock values by pointing out the obvious - that these companies aren't worth what people say they are. Thus, the small investor who bought these stocks on the basis of the advice of these financial channels and other so-called experts and up losing their shirt.
And that is true, to some extent. If you play this game, you will lose. When you buy stocks because they are hyped in the media, chances are you're going to go broke. And I say this from experience. When I first started buying individual stocks over two decades ago, I watched these financial channels and listened to these various idiots with their prognostications. And what I realized was that a "hot stock tip" shared with several million viewers and readers really isn't much of a tip at all. For sure, if I bought the stock, the next day the price would go up. But the price only went up because millions of other idiots like me were also buying the stock.
Meanwhile, the guy making the hot stock tip has sold out. Within weeks or months, the stock price has dropped back down and at best I would break even or worse, lose money. It really wasn't much different than that teenager working out of his bedroom in New Jersey, other than he ended up getting fined and these big players with the financial networks walk away scot-free.
One could argue that regulation should be enacted that people offering stock tips or investment advice in the media should be prohibited from profiting from such advice. If you are going to denigrate a company, you should not also be short-selling it. If you are promoting a company, you should not own stock in it or have a long position. However, such a rule would be unworkable, unenforceable, and unreasonable.
For example, while I am not a advice column, I do discuss various companies in stocks here in my pitiful blog. And some of these companies I own stock in or have sold stock in. I could not longer do that if this was a rule.
If we had such a rule, no one could comment on the value of a company unless they completely liquidated all of their stocks and got out of the market. The only people who could comment on the value of a company would be people who are professional commentators and even then they would be subject to influence and bribery from people wishing to affect the momentum of a stock price.
So what is the answer? I think the answer is not listen to these financial channels and prognosticators. The basic strategies for investing haven't changed in over 100 years: diversify your portfolio, investing rational things, avoid investments that seem to be hyped or vary wildly in price. Don't buy tulip bulbs, it's likely to be a bubble.
Of course, the financial channels would go out of business if they offered that same advice, unchanging, over and over again, day in and day out. No one would watch that channel. No one would read that blog. No one would buy that book.
So instead, we have news based on movement and apparent action. Sound and fury signifying nothing. When a stock shoots up in value we read about it. When a stock drops in value we read about it. When a company turns out regular profits and dividends over a period of thirty years and their stock price gradually increases, you never hear about it.
This is basically how all news works. You hear about terrorist attacks and horrific crimes as well as wild pronouncements of politicians. You never hear about the ordinary working people who just do their jobs every day and don't get into trouble or politicians down in the trenches crafting legislation but not grandstanding. Boring things don't sell eyeballs to advertisers.
Unplug from the media and be happier. And with regard to investing it is important to unplug from the financial media. The best investments I have made over 30 years are things I bought and ignored. The worst were things I read about in the media, or tried to time. Fortunately, today you can go online and access reams of data about companies - everything from their P/E ratio to their dividend history, their debt-to-equity ratio, stock price history, news releases, and so forth. You can also read some so-called expert's opinion about the company as well, but you should take those with a grain of salt.
And yes, sometimes I wonder if I am being baited in this regard. For example, we have been treated with a slew of bad news lately about the economy from some sources, while others are touting the "Trump Bump" and postulating that the economy is poised to take off. It is hard to parse whether these are politically motivated, rational analysis, or an attempt to get us to buy or sell a particular stock.
In that regard, I have probably been guilty of falling into that trap on more than one occasion. I read an article that says a particular industry is going down the tubes and I sell the stock as a result. Weeks later it turns out things aren't as bad as we thought and I feel foolish for getting out so soon.
Buy. Hold. Diversify. There really is no other choice for the small investor. Trying to play the market is playing with fire