The Art of Low Priced Stock Manipulation
Part 1: Understanding the Impact of Margin Rules
Lets explore the impact of margin rules that various brokerages use to see if these rules are impacting the trading in Valence stock. Now, I know the sophisticated traders and investors out there already understand these rules and the game being played, but bear with me until I lay it out so that we can carry on a more informed discussion on this thread.
Most brokers allow margin traders to buy the stock using margin, i.e. borrow up to 50% of the purchase price under Federal Reserve rules, as long as the price of the stock is over $5. Another way to say this, is the Buying Power available in margin accounts can be entirely used to purchase shares of stocks over $5. If the stock is under $5, any purchases count the same as cash transactions, i.e. the buying power drops by twice the amount of the purchase. If a margin player deposits $5000 into a margin account, then they have $10,000 of buying power. They can buy 2000 shares of a $5 stock (ignoring comissions in this calculation for simplicity). They essentially borrow $5000 from the broker. But if the stock is 4.9375, then they can only buy 1000 shares. This transaction counts as using $4937.50 in cash, they can't borrow any funds on the purchase, and it depletes the buying power in this account. If a trader buys more stock than their buying power, then they get a Reg T call for the additional monies, per Federal Reserve regulations. (Note: Most brokers woouldn't allow a margin account with only $5000 in equity, but I'm using the small number to keep the calculations simple.)
After the stock is purchased, the stock counts as equity for the margin maintenance requirements set by that particular broker. This maintenance requirement is set entirely by the broker, and not required by Federal Reserve regulations. The purpose of the margin maintenance is to protect the broker's loan. Many brokers allow low priced stocks to be counted as equity in the margin account until the stock falls below 4, and some brokers use below 3.50 as a cut-off. Others are now using a floor of 3.50, and only allowing any value above 3.50 to count in account equity calculations.
In the hypothetical example I used above, if the trader bought 2000 shares at 5, and used the 10,000 buying power up completely, when the stock dropped below 4.00 (or 3.50, depending on the broker), the broker would call the trader up, and ask him to send in $5000, the entire amount of the loan. Since the stock no longer could be used in margin equity calculations, the trader had to pay off the loan entirely. Even if the trader holds other stocks in the account, if the overall market suffers a decline, the trader can get a serious margin call. This creates an opportunity, in some cases, for stock manipulation.
continued... Paul |
