Blueprint For Manipulation
by Christopher Carolan
The purpose of this essay is twofold. One, to show how a scheme
to manipulate stock prices higher could be carried out without Federal
government intervention or funding. And two, to examine evidence
that such a scheme is currently in place.
Firstly, is there any concrete evidence that stock prices have
been manipulated in the past? Our country is built on a foundation
of free markets. The perception that our markets are free to trade
up or down is widely held by the public. To charge otherwise requires
some specific evidence. That evidence exists in the form of the trading
halts of Tuesday, October 20, 1987 at the bottom of that year’s
crash. While the previous day is now ensconced as "Black Monday"
in the history books, it was Tuesday when the despair was most
widespread and blackest. Stocks continued to fall without a bottom
in sight as margin calls and bankrupted traders rapidly multiplied.
The manipulation scheme here was brilliantly simple and effective;
to change the makeup of stocks in the falling Dow Jones Industrial
Average to a group of stocks that performed better than the index
was doing up to that point. Simply put, the NYSE halted trading in
all DJIA stocks that were dropping. The effect was to immediately
reconfigure the DJIA into an index composed of 100% advancing
stocks! This move resulted in the instantaneous rally of the DJIA
that over the course of an hour or two was able to restore enough
confidence to generate buy orders for the reopening of the heretofore
falling stocks and propel them to a rally stance also. This event, to
which I was a witness as a market maker in the options pits of the
Pacific Stock Exchange, is recounted to make a single point, that the
NYSE will manipulate the stock market when they believe it is in
their interest to do so.
The Tick Bulge
I have been a minute-by-minute participant and observer of the
U.S. stock market for twenty-two years. The patterns of trading
and market participation have constantly changed over those
years, as technologies have changed and as the mix of participants,
retail and institutional as well as their goals (long-haul investing
or instant killing) have changed. But what hadn’t changed
(until recently) is that the participants motives have always
seemed to be anchored in the core axiom of Wall St., i.e. that
the name of the game is to buy low and sell high, whether in that order or not.
The NYSE tick is the most telling indicator for watching stocks
trade over the micro-term. The tick looks at each issue on the
NYSE and assigns it either a plus one or minus one value based
on the last change in its price. Even if the most recent ten trades
in a particular issue are at an unchanged price, the last time the
stock did change will be the tick value for that issue. The net of
all issues’ tick value is the NYSE tick number that is disseminated
every few seconds from the exchange. The tick is very effective
in showing when large baskets of stocks are executed. The NYSE
defines program trading as the execution of a group "basket"
of at least 15 stocks simultaneously. If a basket of 500 stocks is
bought on the NYSE, then all 500 of those stocks will have a plus
tick value and the overall tick reading will likely jump dramatically
to the upside. Quick moves in tick are thus an indication of
program trading. It is not uncommon to see the tick move from
near zero to plus thirteen hundred in less than ninety seconds
as program buy orders hit the floor. The term "program trading"
is considered by some to be synonymous with "index arbitrage,"
which is the simultaneous trading of futures and stock baskets
to profit from price discrepancies. While index arbitrage was the
primary usage of program trades years ago, it now comprises
only 12% of program trades according to the NYSE. In the case
of index arbitrage, one can see why transactions need to be
simultaneous, as there is a corresponding futures trade occurring
and one wouldn’t want to be ‘legged out’ to use the floor
vernacular that describes a half-executed strategy. But program
trading now is not primarily index related. If institutions are using
computers to move large amounts of stocks around, is it
necessary for these transactions to occur in ways that produce
moves of over .5% in the capitalization of the economy in two
or three minutes? When these programs are executed, one
witnesses many shares being bought at sharply higher prices
than just seconds before. Wouldn’t one want to be patient and
accumulate at the lower level for better performance? That is the
natural question an old school, buy-low sell-high, trader would
ask. Indeed it is even more strange that, when prices are at a
juncture where they look ready to fall, and a normal trader
would back-off so that prices could "come in," is exactly the time
these buy programs show up and seemingly pay too much of their
clients’ money for stocks. Why?
Standing Jessie On His Head
Jessie Livermore outlined the normal practices by which traders
could accumulate large positions in stocks without being noticed.
It is considered a consummate skill on Wall St. to be able to buy
large quantities so as to not move prices more than necessary.
It would seem that the program trades evidenced by the tick
bulge do exactly the opposite. Those trades, with their stampede
like quality, magnify the market move caused as the buying
broadcast to trading screens everywhere with a sudden futures
surge and tick bulge. Program trades seem to stand Jesse
Livermore on his head. Program trades are computer executed,
and computers can be programmed to do just about anything.
Why aren’t computers programmed to trade like Jesse Livermore
and accumulate stocks quietly? Well of course they can. Such
technology is already available, such as the client trading platform
of Interactive Brokers, which can execute "iceberg" trades by
representing you on the bid, showing only part of the order, and
adjusting your bid with the market. The question remains. For
what reasons are large, instantaneous programs that obviously
result in poor fill prices for clients used instead of a more steady
and constant method of stock accumulation?
The stock bear market that began in 2000 has devastated Wall
St. and threatened to do even worse damage if it turns millions
of investors away from placing their money in stocks. Those Wall
St. firms who manage public money risk losing much of the capital
under management should a decade-long bear market ensue.
It is therefore directly in their self interest to mitigate the bear
market in whatever way possible. But how could that goal be accomplished?
Hit ’Em Where They Ain’t
When we read that the Dow rose 64 points in one day, we
naturally believe that there were more buyers than sellers that
day. And yet, when we hear of a 64 to 0 football score we don’t
assume for a minute that one team had more players on the field
than the other. In football the name of the game is to get more
men and the ball into the less defended parts of the field. Similarly,
a wise baseball sage once said to "Hit ’em where they ain’t" in
order to win. In war, an outnumbered army can try to concentrate
their inferior forces to achieve numerical superiority in a small part
of the battlefield. A perfect example of this tactic occurred in
World War II where the German army, outnumbered on the
western front, concentrated their forces in one spot and
attempted to break through the allied lines in the historic "Battle of the Bulge."
On a down day in stocks, outnumbered buyers spread across
the front lines of the trading day will not be able stem the tide
of selling. But suppose they coordinate their efforts and
concentrate their buying forces at small discreet points in time
along that daylong battlefield. While outnumbered in the big
picture, the buyers would be able to effectively surge prices
significantly higher. Enough so to morally discourage the "enemy"
bears into short covering, and enough to turn some technical
indicators their way, which in turn would encourage still more
defections from bear to bull camp that might over time be enough
to change the course of the "war" entirely.
For such a manipulation to occur, we would have to believe some
incredible things about Wall St. That type of manipulation would
require funds/firms to buy stocks with their clients’ money at
artificially high prices, i.e. during the tick bulge. As such, those
funds and firms would be deliberately hurting their clients’
performance. They would be violating their due diligence obligations.
To what end would they do that? One could rationalize that it’s
better to buy the top of the day in a rising market than the low
of the day in a falling market, but remember the big-picture goal.
A rising market means more funds under management. Such a
manipulation would have the funds/firms exchanging client
performance for quantity of funds under management. Well of
course we know the funds/firms would do such a thing. What I
have outlined is exactly the unethical underpinnings of the
current Mutual Fund scandal unearthed by the New York
Attorney General, Eliot Spitzer. In 2003 Wall St. firms have
already admitted to hurting client performance in exchange
for a greater quantity of funds under management. Those who
(often rightly) shrug-off conspiracy theories often point to the
difficult task of proving that the perpetrators actually are devoid
of enough scruples to implement the conspiracy. The New York
Attorney General has already uncovered that deficiency.
How would such a manipulation scheme be carried out?
Let’s look at the retail firms. They generate two types of
orders; orders from the public, where the client will be very
sensitive to the fill price, and orders from managed accounts,
either in-house mutual funds or ‘wrap’ accounts, where
brokers earn a percentage management fee and exercise
trading discretion. The latter orders are not subject to public
scrutiny. The owner of the OPM (Other People’s Money) does
not know what or when is being traded. The push on Wall
Street over the last fifteen years has been to increase the
amount of money so managed. At the same time, there has
been a massive increase in program trading. In fact, numbers
compiled from the NYSE show non-program trading volume is
stagnant over the last few years while program trading volume
has grown sharply. For our purposes then, a retail firm generates
a constant flow of in-house orders (both buys and sells) into
their electronic trading system. It would be simple enough to
allow the sell orders to dribble out in a steady stream causing
minimal ripples in prices while allowing buy orders to accumulate
behind a ‘dam’ only to be unleashed in a fury of buying that
lurches prices disproportionately higher. A Wall St. firm could
manipulate stocks higher by assuring that their buy orders,
through concentration, achieve a disproportionate effect on
prices when compared to dispersed sell orders.
There are problems with this theory. Why would one firm
sacrifice their performance for Wall St.’s greater good at the
expense of unfavorable comparisons with other firms? There
would have to be a few of the largest Wall St. houses involved,
each doing their share, if not actually coordinating simultaneous
buys, at least all actively pursuing the same strategy. At this
point the idea may seem improbable, because such coordination
would have to be made at the highest levels of the NYSE. Could
you imagine the Chairman of the NYSE being given the responsibility
of slaying the great bear of Wall St. through such a scheme? Why
if he were successful, I would expect the NYSE compensation
committee, (which includes the chairman of program trading
behemoth Goldman Sachs) to vote a very hefty compensation
package to Mr. Grasso for his efforts. And you thought Dick
Grasso made 147 million for ringing a bell twice daily!
Recent years have seen a growing acceptance of the role that
psychology plays in market direction. The technical analyst used
to be the odd and underrepresented member of the Wall St.
strategy team. Now, "Behavioral Finance" is taught worldwide
at the university level with cutting edge research being done on
the concept of ‘investor herding.’ It is a very small leap to consider
that Wall St. could be using the shock of sudden, programmed,
price surges as a figurative electric cattle prod upon the investor herd.
My own thoughts on potential manipulation gelled this summer
when the most egregious behavior seemed to be occurring.
There, in the midst of August, low-volume doldrums, and always
just as a market downtrend would begin to gather steam, would
come a buy program whose volume and instant price mark-ups
were way out of line with the flow of trading.
For those who would deny that any manipulation of prices occurs
on the NYSE, I would like them to answer the following questions.
How is a client better served by having their order filled at a
drastically higher price than existed seconds before their order hit the floor?
Why do large programs on quiet days hit the floor just as stocks
are gathering downside momentum? Isn’t the client better
served by waiting for a washout and then buying lower?
What exactly did Mr. Grasso do that’s worth $147 million in compensation?
The topics of how program trades are executed and how retail
firms combine orders into baskets of stocks and how they determine
"when" to execute such baskets when presumably some of the order
flow must be relatively constant are all fertile areas for investigation.
I do not have experience on the conventional "sell side" of Wall St.,
Perhaps there are some reasonable explanations for what some
perceive as manipulation on Wall St.
Christopher Carolan
President Calendar Research, Inc.
calendarresearch.com |
