Hello, friends in this article I will tell you about the Dark Side of the Stock Market.
How does Stock Market Manipulation work?
What is Insider Trading?
How do some people exploit the stock market?
What are the adverse effects of the stock market on a person and on society at large?
These are things that people rarely talk about. But these are quite common. That is why in today’s article on Finance, let us see the dark side of the stock market.
Many of you might invest in the stock market, I do it too, so I am not saying that the concept of the stock market is wrong, but the things that I will show you in this article will force you to think from a fresh perspective. And you would be able to make better decisions when you invest your money in the stock market next time.
WHY STOCK MARKET EXIST?
Have you ever thought about it, friends? What is the need to have a stock market? Why do stock markets exist? What would happen if stock markets ceased to exist?
There is a simple reason for it. For big projects, big companies need a lot of money. No one person should own a lot of money. Through the stock market, people can invest their money in companies so the companies can fund major projects and produce creative ideas. People get a share in the company in exchange for that. It means you will get a piece of the profits when the company makes money in the future. You are on the hook if the company loses money. That is how the stock market works.
How a Common Investor Thinks about their Profit.
If you look at the stock market from the perspective of a common individual, a common investor looking to invest in the stock market, Suppose, you are an investor that wants to invest in the stock market. And you have the option of hundreds of companies. In which company would you invest your money? What would you consider before investing? You would ask which company would give you the most profit. For the money that you’d invest, which company would give you the highest return on investment? If I tell you that I have the secret information about this Company X, that this company would soon get big funding due to which, its stock price would increase rapidly in the future, so you should invest your money in this Company X. And if I give this secret information to you only, wouldn’t this gamble be unfair for the rest of the people? Because they don’t have this secret information that the stock price of this company will soon go up. Friends, this is the game of insider trading. Generally speaking, Insider Trading means making a profit by using such information, that is not available to the public. This ‘Insider information’ can be leaked by any insider whether they are the employees of the company, or an executive of the company, or the accountant of the company, if they use this information to invest in the stock market, then it would be unfair. It would be Insider Trading. And if they tell this information to a friend or an outsider that is not a part of the company, even then it would be termed Insider Trading. But it is not illegal to reveal this insider information in all cases. Let’s take the example of a journalist. If a journalist is carrying out an investigation, and for that, he is analyzing the insider information of the company, the earnings data, or the profit data, that aren’t publicly available, it is legal to do so. Because the journalist is looking at the insider information only for his story as is his job. But if the journalist, during the course of his investigation, comes across the information that such and such accounts of the company are managed in a way that it can be reasonably predicted that the stock price of the company would go up or go down, and the journalist uses the information to earn a profit, then it would be Insider Trading.
Now you’d wonder friends, who’s checking if your friend is working in a company and he tells you the insider information secretly, and you use it to make a profit without anyone knowing. True, it is quite difficult to track these things. And for this reason, friends, stock market manipulation like this is quite common. Not only in India but in the rest of the world as well. In fact, not only this to prove this type of stock market manipulation, that a crime has been committed, is extremely difficult. Because there is a lot of grey area in between.
How Large Company do That
Let me use a real-life example to explain this. Goldman Sachs’ alleged Aluminum Scam. “The New York Times reported over the weekend that Goldman Sachs is running a scheme to artificially inflate aluminum prices” “An aluminium warehouse controlled by Goldman Sachs holds the equivalent of a quarter of the annual North American demand for the metal but only offloads or distributes a required minimum of 3,000 tonnes a day. No more, no less. Whatever the demand.” What happened is that a branch of this bank is involved in aluminium production, and they controlled the supply of aluminium in such a way that the demand for aluminium keeps on increasing and so does the price. And then they invest in the Aluminium Futures because they basically can predict the future prices of aluminium. This was about how insiders can illegally exploit the stock market.
Negative Consequences of decisions of common Investor in Stock Market.
Let’s look at the decisions of common investors in the stock market and their negative consequences. If you go to invest money in the stock market, what do you think about it? Primarily, most of you think of profits only. This means that the rest of the aspects are merely ignored. Whether the company is doing good work, whether the ecosystem of the company is good or not, whether the impact of the company on the world is good or bad, these things are completely forgotten by most people. I will use an example. Suppose a company engages in cost-cutting practices and cuts down on the employees’ salary, or fires some employees, and the other employees are working at exploitative salaries, doing so is good for the profits of the company, more money saved by the company means more profits. And the investors of the company see only the profits. So, they’d consider the practices good for them. And they’d want it to happen. This would give encouragement to the company to treat their employees worse. Similarly, if a company is harming the environment, suppose it uses harmful chemicals to produce its products because it is cost-effective to do so, enabling the company to gain more profit. Or they release their chemical exhaust into our rivers. Because processing the chemicals is expensive, leading to lesser profit. or they literally dump garbage around us because it is expensive to process the garbage. That is allowed within the legal limits. These are detrimental to the world. But the people investing in the company, blinded by the profits, would not realize these things because they want their return on investment. And this leads to a major negative consequence. The effect does it have on the end consumer shouldn’t be forgotten either. Because if the companies focus only on profits, they are encouraged to make greed-based products instead of need-based products. For instance, your breakfast. Often companies market their products as something that you need to have with milk, but it’s 70% sugar, or the sugary cereals that you should eat in the mornings because everyone eats it. This impacts your health and obviously, the company ends up making a profit. But if you eat homemade food for breakfast like milk, lassi, or porridge, no company would make a profit out of it. And neither would any shareholder get a return out of it. So often people, knowingly or not, end up encouraging these things while investing their money. The simple solution to this is that think before you invest in the stock market about the company, you are considering investing in. How are the products of the company? What is the impact of the company on our environment, our society, and on people, in general?
The Herd Mentality of Investors
Most people investing in the stock market, run after the herd mentality. They don’t check the performance of the company themselves, the closing statements of the company, what the company actually does, they simply see that their friend has recommended investing in that company, or the company is discussed in the news and all the investors are talking about the company so they too should go ahead and invest in the company. It matters way more than the actual situation of the company. And there is a really simple reason behind doing so. The more people invest in the company, would drive up the share price of the company. And the return on your investment is also increased. Consequently, the stock price or the share price of the companies does not always depend on their performance instead, it depends upon the company’s image in the market. And the image can be built up and taken down quite easily by using PR machinery and advertisements. By employing paid news and brand ambassadors. All of these have a psychological impact that can eventually influence the stock price of the company. Imagine I bought a lot of stock in a small company at a low price. And then, I go and pay news channels and print ads, employ PR machinery and run trends on Twitter that this company is about to get huge. Urging everyone to invest in it. There’s a lot of positive publicity, because of this more people invest, and the stock price of the company goes up. I get a lot of profit and then I sell off my stocks. Suddenly, the stock price of the company would crash because I held majority shares or a significant number of shares. Friends, this is known as the ‘Pump and Dump’ Scheme. First, pump the stock price into rising, and because you own a major portion of the stock, sell it off later. Dump it and then its stock price would go down crashing. Do you know what’s interesting? The same thing can be done in reverse as well. Basically, you can bet on a company performing terribly in the future. In such cases, you can buy Shorts, if you think that a company is going to perform badly in the future, and if this actually happens, you can earn profits off of it. But imagine this, as I told you, Pump and Dump schemes are practiced, similarly, if you get a Troll army, or use paid media systematically to malign a company, to a level that the investors lose their trust in the company, and its stock price crashes, if you had invested in Shorts, then you could earn profits from it. This is known as Short and Distort. Basically, it is the opposite of Pump and Dump. And in a country like India, where rumours and fake news on WhatsApp spread like wildfire, you can imagine how easy it is to do so. People work as herd mentality in the stock market. Pump and Dump and Short and Distort, are different from Insider Trading. Because the criminal in Insider Trading is an insider or someone that knows an insider. They knowingly exploit price-sensitive information. But in these cases, in these cases, it is the collective public that acts like a herd and they think that they have insider information when they see any false rumour over WhatsApp or come across any rumours in the news, and based on it, they take an action. And overall, friends, there are so many ways to manipulate the aspects of the stock market.
Bubbles and Crashes
Now, mix all the problems and manipulations and look at the chaos it creates. Imagine a company using stock manipulation tactics, to earn its profits. And since people are driven by profit-motive, people invest in it. And because people have a herd mentality, since one person is investing in it, the others would want to as well. Things worsen exponentially. The company earns more profits, the stock price goes up, people invest more in the company. And as long as people are unaware of the manipulation, the company ultimately benefits from it. And such things eventually create Stock Market Bubbles. Shareholders, the people that have invested in the company, have never visited the headquarters of the company. They don’t know much about the company, about its performance, But the on-ground situation of the company may be really bad. Often, there is corruption among the people in the company. They execute a scam to rob people of their money. And when such a bubble bursts regarding a large company, then the entire stock market crashes and often it may even lead to an economic crisis.
The biggest example of it is the 2008 Economic Crisis. It was created by the US Housing Bubble. After the 2008 Economic Crisis, people had raised their voices against Wall Street and had even protested. People questioned how it could be that the stock market is manipulated by these large companies in their favor and it is the common investor that bears the losses. On top of it, people found it irritating that the government had bailed out these large companies and banks. Even they had done. Another interesting fact, it is said that Bitcoin was invented just after this. As a decentralized tool. People were fed up with the government’s central control over banks and the economy. So, it is said to be one of the major reasons for making Bitcoin. Bitcoin will not be controlled by any central bank or central agency. It will always be a decentralized tool and will create an alternative financial system. The negative aspects of the stock market that I listed out in this article, most of them are valid for cryptocurrencies as well. In cryptocurrencies as well, there have been several Pump and Dump schemes where people publicise up a random coin keep a major share of it with them, and when the price increases, they Dump it and walk away with all the profit. Profit-motive and herd mentality are also clear in cryptocurrencies. When people invest their money in it. But one thing is certain, there is little to no scope of things like insider trading in cryptocurrencies like Bitcoin, because it is a decentralized thing a central company does not control it. So, no central company can manipulate it in a way that stock prices are manipulated.
Despite all these, I would not tell you to give up investing in the stock market. It is not so. Invest in it. It is only that you should keep these things in mind. You need to be conscious about these things and you should know that these do happen. And how you can avoid them. Think and make better decisions.