High net worth traders who are insiders create market volatility
By R. M. B. Senanayake
One thing that struck me about the stock market performance in the last 2 years is the high volatility of the shares. It is as if someone is pushing up the share price way above its intrinsic value and then allowing it to come down steeply. To push up the share price it is necessary to buy at higher and higher prices while spreading information that the price is set to move up to some fancy level.
The reality is that in their crusade to manufacture extraordinary personal wealth, a few high net worth individuals who also are large shareholders of individual companies and hence insiders have engineered volatility into the stock market.
Such high volatility destabilizes market for a particular share, but it creates innumerable trading opportunities for proprietary traders among Broker firms and among high net worth individual traders. These traders feed off each other.
The game is simple: High net worth traders who are insiders create market volatility. The investors know that they are not in the know of many things despite the Stock Exchange Regulation which require companies to provide timely information about any price sensitive matters. Directors and controlling shareholders are supposed to disclose to the Stock Exchange as soon as some price sensitive information is available and Directors and large shareholders who are considered ‘insiders’ are prohibited from dabbling in such shares until the information has been published. But is this rule observed? The SEC should check the trades of such individuals and their connected companies to ensure that there was no insider trading. Individual small investors realize that they need to depend on their Investment Advisors to understand the movements in the market and these Advisors have encouraged their clients to trade instead of invest. Invariably the client is willing to give the Investment Adviser the absolute discretion to buy and sell. The Stock Exchange Regulations require that in such cases the clients should be called upon to sign a Discretionary Agreement. But hardly any Investment Advisor has insisted on such agreements from their clients. .
By increasing volatility in the stock, the brokers and high net worth traders have created a money making machine. Obviously, without the manufactured volatility, markets would be more stable, predictable and better serve economic development and growth. But there are no extraordinary gains to be made in calm and stable markets. The game, invisible from the surface, is designed to accomplish several things. If you control a venue that generates a lot of buying and selling, you can “internalize” the order flow. That means you don’t have to trade outside your house – you match orders internally because you have so many buy and sell orders coming in. And then there are transaction fees.
If you are the “house,” you can also take the other side of any trade you want, which has its advantages. But the biggest advantage these broker firms have is that they “see” what orders are coming into them. And, regardless of whether or not it’s legal, they trade against them and take advantage of knowing the specifics of other pending orders that can be used to backstop losses. .Individual employees when they resort to such trading are said to be front running. What about the firms themselves?
The writer is an economist and is the General Manager of a Colombo based stock brokering firm. You can reach him via raja.senanayake712@gmail.com
