Honest users of the ‘pump and dump’ method in stocks short-sell and make a killing.
On Thursday, the ICICI Bank scrip see-sawed on false rumours of a US lawsuit. ICICI has high weight in both Bank Nifty and Nifty itself. It is one of the most liquid and heavily-traded shares in the world.
The first response to the rumour was blind panic with the stock being hammered. There was a quick recovery as bank officials responded with categorical denials and those were accepted by investors as credible. In the end, the stock closed nominally up at Rs 879, with an intra-day high-low range between 846 and 891. As many as 1.16 crore shares were traded and around 32 lakh shares were delivered.
The Economic Offences Wing (EOW) reacted quickly, picking up two Mumbai-based traders on Thursday evening. These two are suspected to have played the part of “early birds” in spreading the rumour. Presumably a large part of the evidence is electronic in nature. Given the Net and mobile communications, within a very short time, the rumour had propagated to millions. The bank's officials did a commendable job using the same channels as well as TV to restore confidence.
There's no point going into conspiracy theories until more facts emerge. Anybody, who can induce a violent fluctuation in a largecap and get away with it, stands to gain. Sebi will have to try to establish culpability by sifting through trade data. Given good data-mining algorithms, they can narrow down likely suspects.
However, establishing guilt could be very difficult unless the EOW have got hold of the right chaps and extract confessions by old-fashioned means. Any trend-following trader could have been on the right side of the stock just by following through on mechanical technical signals. In the morning, there was selling on heavy volumes and that generated sell signals. By 1.30-2.00, the trend had clearly reversed.
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Also, while it may be logical to assume that the person(s) who sparked the rumour were heavy sellers, this is not necessarily true. There's no entry barrier. It is very cheap and quite easy to seed a rumour across the Net and via SMS. Once it gains traction, entirely innocent people will do the work of further propagation. “Pump and dump” frauds, as these are known, occur times without number in the most sophisticated markets. Sometimes the culprits are teenagers trading tiny amounts.
Another thing: Even if the culprits are found and condign punishment meted out, it will be impossible to compensate the losers in the momentum trades that occur while such rumours are in force. Hence, at best, damage can be minimised by quick responses as in this case. It cannot be entirely prevented.
In this particular instance, the impact was a little muted because ICICI has such high liquidity. If we look at the NSE data for the past 21 sessions (excluding Thursday), average trading volumes are around 43 lakh per day, with 17.7 lakh delivered on average. The average session high-low swing is around Rs 36.
So, the rumours led to a 170 per cent jump in volumes, around 80 per cent increase in deliveries (32 lakh) and the session's high-low range of 46 was fairly close to normal levels. There's discernible impact from the rumour. But while it was an unusual session in terms of trading patterns, it wasn't extraordinary. There's very little an investor can do to protect himself in such circumstances. After all, the rumour may be true – remember Satyam. Probably the best recourse is to go with the trends as suggested by the technical position and hope to emerge with an intact skin. Unusually, this was a short-focussed pump and dump scheme. Most pump and dumps are long-biased and designed to push stock prices up. The classic rumour-technique is to use blogs and forums, mix some truth with some optimism and outright lies, and sell after prices rise.
One honest short-focussed operation that uses pump and dump methods is sharesleuth.com in the US. Sharesleuth is run by Chris Carey, and funded by trader Mark Cuban. Carey, who is an investigative journalist, unearths damaging corporate information and Cuban short-sells. Then, Carey discloses the facts and publicises them, with full disclosure of Cuban's positions. At that stage, other shorters generally get into the act and Cuban makes a killing.
It's an ingenious concept and a “whitehat” adoption of a technique borrowed from fraudsters. It is unlikely to be widely emulated because everybody from corporate officials to market-regulators hate short-sellers. This is a great pity because such short-focused operations could provide counter-balance to the barrage from the long-side.