- Oilman Jim's Letter
- Posts
- Advanced Market Knowledge - Part 3
Of course, none of it is meant to be like what I describe. It is meant to be an orderly market of serious companies with genuine projects making full and complete disclosure of all material information to investors. That is not always the case, though, and the only way many of these companies can function is via what is called “market abuse.” In the old days, this would simply have been known as fraud.
Many participants potentially can be involved: first are the company directors themselves when they interact via regulatory announcements, presentations, interviews, investor lunches or evenings, and make direct contact with investors. These people are regarded by the majority of investors as the most credible sources of information, thus they are capable of doing the most harm. The character of the type of person who decides to set up a small public company aimed at speculative, sometimes desperate, investors is not always the best, so I would treat any information from these types of companies with a degree of caution, in the worst cases assuming it to be false, unless established otherwise. Even the more honest ones can have a tendency to exaggeration and wishful thinking, so again, even though people can think they are receiving possibly privileged information “direct from the horse’s mouth” it is wise to be cautious about what they say and try to verify it from genuinely independent third party sources.
Outside of the directors, brokers usually have the greatest financial interest, plus the ability and necessary contacts to enable market abuse. They can do this either themselves, through the publication of analysis and reports which exaggerate the opportunity and ignore or play down the pitfalls, the setting of overly optimistic price targets based on their defective analysis and their promotion of the company along with their misinformation regarding it to clients both existing and new, either face to face or on the telephone, and/or through the use of promoter contacts. Again, think about what type of person would choose to represent some of these companies and/or their control parties. They are unlikely to be an altruistic type with their clients’ best interests at heart. Information from brokers is best taken with a large pinch of salt.
Some promoters are retained directly by the company and payment to them is disclosed. These are usually operators of investment orientated websites, who will profile the client company’s information and organise interviews with the directors and CEO. This all will be disseminated on social media, linking back to the site containing further information. They will try to present the company in the most positive manner possible, but that of course is just what they do and are paid for. Surprisingly, though, many investors do not realise that these commercial looking sites are in fact businesses and believe that they represent a source of independent information, with their owners providing this content and undertaking the work for selfless reasons, because, like them, they are fans of the profiled companies. This situation often arises since these type of investors only know about and buy the shares that are being actively promoted by these sites and other retained and compensated promoters. They never even think to read the sections and pages of the website entitled “terms of service” or “disclaimer.” Nevertheless, these sites are what they are. The straightforward ones do not purport to be independent; even the less straightforward ones explain what they are doing in their small print and disclose that they have paid relationships with the companies featured on the site.
Many promoters are retained either by the companies or their brokers, or through other intermediaries or third parties, and their compensation is not disclosed. Some of these also operate web sites, less professional looking usually, without full disclaimers, providing interview facilities, often conducted in a more informal, less commercially apparent, manner. They deny the receipt of any compensation, even when questioned directly about it, presenting themselves as “independent,” which of course they are not. Just that by itself constitutes market abuse right from the outset, without even considering what further misrepresentations they may make, of which there will be many. Often they will falsely claim to be buying the shares themselves and adding even more if, more likely when, the price falls. Essentially what they are engaged in is deception, but they do not care and adopt a general “holier than thou” attitude, tut tutting at the activities of other companies which are not their clients. These types generally appear and start to swing into action before placements to help move up the share price of the client company and increase liquidity in the market to help and facilitate naked shorting by parties close to the company, which will then be covered at a substantial profit in the upcoming financing.
Some promoters are not paid and are not retained by the companies either. They simply choose a company they think has a good story, and most importantly a tight market, acquire a line of stock and promote it with the aim of moving the share price up, selling and making a profit. It is known as “scalping.” Regardless, many investors appear to think that this is “the game” and they play along enthusiastically. I am not sure that those outside the inner circle necessarily understand that they are likely to be left “holding the baby” and usually they are just creating additional volume for others to sell into. With the advent of social media, everyone can be a promoter if they want to and some who see the angle take advantage of that.
Bulletin boards and social media are the homes of the latter two types of promoters, who will use multiple accounts for maximum effect. Generally, they specialise in the misinterpretation of presentations and regulatory announcements and, using multiple identities, create an atmosphere of excitement around the companies they are promoting. If the story from the company as it stands is not strong enough and it can not be made sufficiently powerful through a misrepresentation of the existing material, then the promoters generally will just lie and say whatever needs to be said. Whether it is due to the selling of shares in anticipation of a placement or the selling of shares bought specifically to be flipped, the buyers generally, perhaps rather invariably, are being deceived by the posts made by these promoters. Many traders of course do not mind, they just see it as the way the modern market operates and are happy to repeat the lies themselves if it suits them.
Interviews have become a major promotional tool, with investors affording much credibility to them. What most do not realise is that unlike the type of interviews they are used to on television, micro cap companies pay these “interviewers” to “interview” them. They are stage managed, with questions agreed in advance and the company has the right to edit the interview afterwards. Many misleading statements are made by directors in these interviews and, since they are paid, the interviewer does not correct them. With both a dishonest director and a dishonest interviewer, these productions can turn out to be prime examples of market abuse. There will never be any actual new material in them (that can only be released in a regulatory announcement) and they should be viewed only as marketing.
Regulatory announcements generally are truthful, if not necessarily telling the full truth. Wording can be used that while notionally the truth will in fact be misleading to novice investors, those unfamiliar with the ways of the market and promotion, and those not fully informed about the ways and methods of operation of the company’s industry. You see the impact of this all the time on the bulletin boards and social media when people discuss regulatory announcements, thinking they mean, or deliberately interpreting them to mean, something other than what they actually say.
Misinterpretation of regulatory announcements by promoters is one of the main areas of market abuse. Very few novice investors read them and even those who do rarely fully understand them, often reading into them what they themselves would like the situation to be, rather than what it actually is. Many investors are their own worst enemy, since very few people are able to accept that they were wrong. This of course makes the work of the dishonest companies and promoters really quite easy.
Some social media promoters go further and concoct their own stories, often involving invented or speculated upon takeover bids or major contracts. If there is no actual material out there in the public domain upon which to base a fictitious story, then many promoters will just fabricate it, posting whatever they have thought up as false material on a fake news site. Serious investors of course see through it quite easily, but those who want to believe it do. Sometimes the company is involved too and provides regulatory announcements which can be misinterpreted to suit. An example is a contract entered into in the normal course of business with a household name, which transacts with all on the same basis, first being announced by the company, then massaged by the promoters into an implied endorsement of that company by the household name, or even an indication of a takeover interest.
Many like to trade these plays, which if done “right” can be hugely profitable, going on for some time, even rising to unanticipated heights, and they do not care if the story is false. They will still be happy to retweet and share the fake news if it suits the position they hold. Investors are delighted to hear the news and rumours, even if they are fake, and again will redistribute and even defend them against those who are calling them out as false. Even when everyone else has sold out and the price has collapsed, many still hold on to hope, trying to preserve the dreams of riches which enticed them in the first case. In comparison, the initiators of the false story have profited, often significantly, and moved on. Again, it is accepted by many as just part of the way things are these days.
Bulletin boards deserve a special mention, since so many people use them as their sources of information. The principle of these is fine, providing there actually is balance, with both sides of the argument allowed to express themselves. Unfortunately, it appears that certain parties are able to get posts which they do not like removed. This is done either by filing multiple complaints with the administration who do not really examine them or assess the merits, and indeed can be done just by one party using multiple accounts, or on instructions by the companies and promoters who pay for additional facilities on these sites. It is extremely murky and highly abusive. Few realise that the moderation is, in fact, biased.
Financial writers also can be included here. As detailed before, many accept payment, directly and indirectly, and are not necessarily independent in the way that people believe. Depending on the audience of the publication, some can have a significant impact. IR companies play an important part too. Their essential service is to provide a contact point for investor enquiries, a service which appeals to those directors and CEOs who are nervous of direct contact and communication with their investors without a protective moderator present in a controlled environment. It is always a good test to see how much a company hides behind them. Many do.
* * *
Having covered the subject of false or misleading statements being made by various parties in the course of certain activities which constitute market abuse, the other aspect is manipulation of prices and volume in the marketplace to give a false indication of interest and demand. The impression of buying activity in the market is a key element to catalyse people to invest.
It is important to understand from the outset that the very initial opening price of the shares of most companies is essentially arbitrary, unless they actually are obtaining genuine funds from genuine institutions on an arm’s length basis, which is not always the case, particularly considering the outcome of most of these companies’ projects, the concomitant effects on the companies’ share prices and the need for those institutions investing funds obtained from the public to actually obtain a return if they want to stay in business.
What makes things work for promoters is that most people generally believe that stock market prices are genuine, a result of efficient markets accurately reflecting the value of the company. Authorities (e.g. courts and tax offices) accept these prices as absolute for the purposes of valuation at a point in time. What they do not understand (or prefer not to know, since it would just make everything too complicated) is that at the bottom end of the markets, these prices can easily be rigged.
The opening market price is essentially what those in charge at the company want it to be and in situations where there still is little stock in the market the price can be moved virtually anywhere they want it to be at very little cost. The objective of any stock promotion of course is to sell shares, therefore buyers need to be enticed in. Statements by promoters are not always enough, though, potential investors invariably also want to see market activity and action in the share price. They want and need to know that other investors are buying.
The main way the impression of active, and often substantial, trade activity in the shares is achieved is via “wash trades,” essentially matching sales and purchases which are put through the market by the same party in order to create volume. These will be disguised by breaking down the transactions into unequal parts to create the impression of genuine buying and selling. Multiple parties, which can of course all be the same person behind the scenes, also are used to make it appear that there actually are changes taking place in beneficial ownership. Using offshore entities and initiating the orders through financial institutions and brokers located abroad makes it difficult, if not virtually impossible, for a regulator to prove.
With little genuine volume in a market, the share price can be moved up or down with small amounts of actual buying or selling. Flurries of buys can be created to give the impression of immediate investor interest and the price can be continuously moved up to draw in those worried that they might miss out. The necessary patterns even can be created on the charts if necessary to lure in those who invest based upon technical analysis. Not only is the story at the company often a lie, the action in the market often is too. With these smaller companies, caution is the watchword in all respects.
At the lower levels, the same methods are used by those in certain social media groups to create market activity to catalyse buying in their own promotions. Not only should the words being used to promote these companies not be believed, neither should the market activity in their shares. Every single morning, large numbers of investors are lured into buying shares in these types of promoted companies. Virtually all are out of pocket by the end of the day.
There are large numbers of new marks arriving in the market every day for the promoters to exploit, since the retail base is much broader now with a vastly expanding investor audience. The principal reason for that is technological change and the ease of opening an online trading account. Many providers now offer a smooth and fast “on boarding” process simply via an app. As a scan of the message boards will show, most, in fact virtually all, of these new investors are utterly clueless. They may know a little about the theoretical basics, but nothing about the way it actually works in real life. This is the prime audience for promoters now. These newcomers have read about the success of others and think it is easy. Now they feel privileged to be receiving information from what they believe is a top tipster or social media “influencer,” whose endorsement and praise actually mainly comes from their other social media accounts - and often ironically their victims.
The reality is that the promoters can say anything and their audience will believe them. These new investors generally do not undertake any research of any nature, other than reading the social media comments of like minded individuals who reinforce their own points of view. They buy only because they think the share price will go up. They have no interest in anything other than that. The details do not matter to them.
Of course, the sheep get shorn, but they still come back time and time again (this time is always different they think) even sometimes defending the promoters who caused their losses. It is a quite remarkable situation and the few who do wake up are quickly and readily replaced by further, equally gullible newcomers.
Even market collapses do not shake out their numbers, such is the power of greed and peoples’ belief, and desire, that riches may be just around the corner.
There is an important psychological aspect in that stock market activity is not perceived as gambling, but rather as investment. Very few would believe that wealth actually could be gained through betting, but most do believe it can be gained by buying shares. Stock market investment also has an aura of respectability, which is lacking from speculative alternatives such as Forex or Crypto. The sad truth, though, is that in respect of micro cap shares, the average newcomer probably would have more chance of success playing slots.
Returning to the subject of price manipulation, like analysing and researching non-existent fundamentals, it is also best to beware technical analysis of something that often is artificial too. Regarding volume, in some markets large numbers can be created simply from the rollover of trades, where settlement is extended for a further period of time in return for paying the market maker a small spread. Always watch out for this, since it can hugely distort totals for what otherwise would have been low, or no volume days. There actually is often very little genuine volume in many of these companies’ shares.
The other side of the coin here is that a lot of trading now is not going through the traditional markets. Companies offering CFDs (contracts for differences) and spread betting are becoming more and more popular. Much of their exposure is hedged in the actual markets, but with the increased interest in shorting, CFD and spread betting providers take advantage of the fact that their customers’ differing views can often provide a natural hedge. Thus there may actually be more interest in a company’s shares than indicated by volume in the actual market, but not necessarily all translating into net buying (hedging in the market by the CFD and spread betting providers), which is what is required if the share price is to move up.
Furthermore, since the majority of customers lose, it is relatively safe for the CFD and spread betting providers to operate as “bucket shops” in the classical sense of the term, where the customer orders are not actually sent to the market (just thrown into the bucket) and the house takes all the risk.
The main attraction to investors of the CFD and spread betting providers is that they offer leverage. The big disadvantage is that they trade using the published spreads, which for micro cap companies often can be substantial, sometimes 10%, or even more. Trades through traditional brokers which are actually routed to the market are executed with spreads which are very significantly less.
Leverage in some markets also can be obtained via traditional brokers simply through the use of extended settlement. This will depend upon the broker’s view of the client’s financial strength to absorb the potential loss if necessary and the attitude of the compliance department. Such trades also can be rolled over to extend settlement even further, although some brokers impose limits on this.
Gains/profits from spread betting also in some countries are tax free. Obversely in those countries, spread betting losses cannot be offset against capital gains. The thinking behind this is that more people lose money than make it from gambling, therefore, it is better for the national finances to leave punters' winnings or losses outside the taxation system.
Moving back to fundamentals, as I have questioned before, how much does the truth actually matter in any of this. If the company can put together a credible, compelling story which investors believe, and that story is capable of moving the share price significantly higher, does it really matter how good the company’s underlying reality is if one is only trading it short term?
First, most people, in fact the vast majority, are not going to know whether the story is true or false. They are going to be driven by their perception of it and that is what will determine whether or not they buy and in turn, subject to whatever selling there is, whether or not the share price will rise. That caveat regarding selling is one of the reasons why I said previously that it is essential to know what selling there may be and at what price.
Second, the vast majority of these projects will eventually fail from a commercial perspective, so whether or not the initial premise is true is often irrelevant to any long-term investment consideration, since they are never going to get there anyway. If one was investing only on the basis of a final outcome, there would be very few companies indeed to buy in these micro cap markets.
The story being true does have additional strength, though, since it opens up buying and endorsement from those with more knowledge than the average investor, plus the possibility of a farm-out of the asset. It reduces, but does not totally eliminate, the risk of short-term involvement, and while a partnership or farm-out with a known company is no guarantee of success, it certainly adds credibility and helps bring in yet more buying again.
The thing is, though, that since it is all promotion based and that really is the most important element of share price performance, a strong, believable story probably is more important than the actual fundamentals, which at the best of companies, upon deeper examination, rarely are that strong.
It may sound cynical, but in reality the whole micro cap business is. To succeed in these markets, investors and traders have to be so too.
Part 4 next…