Stock Exchange Trading
Triggered by COVID-19 (Coronavirus), we have seen increased fluctuations on the global stock markets since mid-February. The stock exchange infrastructure is currently being used as intensively as it was recently during the BREXIT decision and the financial crisis in 2008. As a reliable infrastructure provider, it is the task of the stock exchange, especially in turbulent times, to ensure transparent trading and to enable investors to sell or buy securities at any time. If a stock exchange closes, and this has been shown by the historical experience of 2008, this causes even greater panic among investors and irritation on the market.
Overview of the Most Important Protection Mechanisms
On majority of exchanges in Europe and elsewhere, there are stability and protection mechanisms that have been tried and tested for decades. Technical and functional mechanisms ensure smooth exchange trading even in extreme market situations.
Slowdown through the Price Volatility Interruption
The volatility interruption is one of the most important protective mechanisms in the trading system. Also known as “circuit breaker”, it has been making a significant contribution to preventing abrupt, unintended price jumps for decades.
If the potentially next stock exchange price lies outside pre-defined limit corridors (based on a clear methodology publish by the Stock Exchange), the price is not formed immediately but a volatility interruption is initiated and trading is interrupted for few minutes. This has the advantage that orders are collected until the next price formation and liquidity is bundled. The short break gives market participants more time to analyze the situation. If necessary, changes can be made to the orders (e.g. in price or quantity). If trading continues, a price is created which is made up of several orders and which reflects the market opinion better than a single price fixing.
In the case of particularly large price jumps, trading can be interrupted for a longer period of time. Here too, continuous trading is automatically continued after the volatility interruption, unless the next potentially large price jump occurs, in which case trading is again interrupted (volatility interruption). Volatility interruptions can occur during continuous trading or also after the end of auctions (volatility interruption extends the auction).
Other Protective Mechanisms
From order entry to the Stock Exchange’s electronic trading system, to price formation on the stock exchange and also in post-trading – the capital market industry and stock exchanges have numerous protective measures in place. Pre-trade controls, such as validation of the maximum order volume, prevent orders with too large a volume from being entered in the order book. On the way to the stock exchange, technical throttling of the lines protects against overloading the trading system. The maximum number of orders per trading participant per second is limited. The volatility interruption prevents unwanted, rapid price jumps, as described above. The random end of auctions protects against market manipulation. The highest level of settlement security also exists in post-trading (also known as clearing-settlement process). In clearing, all participants deposit collateral to guarantee the execution of transactions. All these steps strengthen the confidence of trading participants in exchange prices.
Source: Taken with few changes from Vienna Stock Exchange
A pump and dump scam is the illegal act of an investor or group of investors promoting a stock they hold and selling once the stock price has risen following the surge in interest as a result of the endorsement. Here, we take a closer look at how pump-and-dump schemes work and how to avoid them.
The Basics of a Pump-and-Dump
Pump-and-dump schemes were traditionally done through cold calling. But with the advent of the internet, this illegal practice has become even more prevalent. Fraudsters post messages online enticing investors to buy a stock quickly, with claims to have inside information that a development will lead to an upswing in the share’s price. Once buyers jump in, the perpetrators sell their shares, causing the price to drop dramatically. New investors then lose their money.
These schemes usually target micro- and small-cap stocks, as they are the easiest to manipulate. Due to the small float of these types of stocks, it does not take a lot of new buyers to push a stock higher.
The stock is usually promoted as a “hot tip” or “the next big thing” with details of an upcoming news announcement that will “send the stock through the roof.” The details of each individual pump and dump scam tend to be different but the scheme always boils down to a basic principle: shifting supply and demand. Pump and dump scams tend to only work on small and micro-cap stocks that are traded over the counter. These companies tend to be highly illiquid and can have sharp price movements when volume increases. The group behind the scam increases the demand and trading volume in the stock and this new inflow of investors leads to a sharp rise in its price. Once the price rise has formulated, the group will sell their position to make a large short-term gain.
An Example of a Pump and Dump
During the summer months of the stock below, a pump and dump scheme was initiated by using a “wrong number” scam. A message was left on victims answering machines that talked of a hot stock tip and was constructed so that the victim would think that the message was an accident.
As seen in the above chart, the price rose from around $0.30 to nearly $1.00, a more than 200% increase in a one-week period. This drastic increase was seen along with an equally large increase in volume. The stock had seen an average daily trading volume before the price increase of less than 250,000, but during the scam the stock traded up to nearly one million shares on a number of trading days. The unsuspecting investors would have bought into the stock at around $1.00. As seen above, it fell to around $0.20, an 80% decline in value for those unfortunate investors.
The Bottom Line
Always keep this investment caveat in mind: “If it’s too good to be true, it probably is.” If someone you don’t know gives you a stock tip, stop and think about why they would be so willing to give you such information. Do not think you can make a large and quick investment return because it’s unlikely to happen. It’s also vital that you do your own research about any investment. This should help you avoid being duped by such pump and dump scams.