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Thursday, July 30, 2009

Recipe to ensure a stock market collapse

I previously blogged, how China had a steady waterfall market collapse into the fall of last year. In China, it is illegal to "short" a stock. In effect everyone must place bets by either buying a stock because they believe it will go up, or sell and put their cash into a bank or some other financial instrument.

Without shorting, you don't create an environment where people WANT to buy stock when the market collapses. Instead you create a one way panic, everyone run for the door when the herd believes that stocks won't appreciate,

When you have shorting, people who shorted a stock will buy it back, at some point. Many shorters get so abused (like now), that as soon as they eek out a profit they are quick to cover (buy) to close the short position. Without people short the market, when the herd decides it is time to run for the door, there is little resistance to stop it.

When the US stock market is functioning in a healthy way, the market rises, market falls, but the market tends to return to the mean. At extreme over-buying, shorters and people selling long positions return the market downward. When the market falls a little too far, people short cover positions and bulls buy stock.

What was witnessed today was outright, illegal, market manipulation. Karl of the Market ticker has a video explaining what occurred (Click).

This market has rallied almost 3 consecutive weeks straight up, and in 20 weeks up about 50%. This sort of a rally crushes people trying to short into an "overbought" market. That's fine, if the market is going up on fundamentals. People making bad investments should get punished.

But if the investors short are right (and they are right currently), and the market needs to retreat to find realistic valuations, but manipulation prevents this from occurring, the effect you have is one of breaking the shorter's back.

If you have ever played a game where the house, casino, or other players, where cheating, don't you just give up playing the game? What if, not only they cheated, but took large chunks of your savings? It would be time to stop playing the rigged game and walk away.

IF (I say IF, since I don't have statistics), that is what the market is doing to people shorting, then the market will become unbalanced, have people buying with minimal short positions. People who don't understand free markets will say "great, the market is up, and I'm glad people taking positions it will go down got burned".

When the market turns, I can only hope the people who start losing money, double down, triple down, mortgage to the hilt to buy more stock, to fill in for the shorter's who are no longer there to cover their positions. Otherwise, the US market will repeat China's graph below.
From WebSurfinMurf's Financial Blog

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