During the COVID-19 pandemic, individual investors–especially young ones– have sought to profit from the volatile securities markets. Mostly, this has been done through purchasing individual stocks or options through brokerage apps such as Robinhood. Commonly, these new investors have learned about a “hot” stock through social media, Facebook, subreddit message boards, topic-specific chat rooms, or other discussion forums. While it might seem advantageous to follow the crowd, sometimes this can lead to large investment losses.
Short-term trading can often be deadly. And, when it is done through the use of margin, options or short sales, investment losses can be magnified. In January 2021, during the COVID-10 pandemic, the SEC cautioned investors about the dangers of investing in a volatile market, such as:
1. Investing in Bubbles or Manias. Financial “manias” or a “bubble” is the rapid rise in the price of an investment, reflecting a high degree of collective enthusiasm or exuberance regarding the investment’s prospects. This rapid rise is usually followed by a contraction in the investment’s price. The contraction, or “panic” occurs when there is wide-scale selling of the investment that causes a sharp decline in the investment’s price.
2. Momentum Investing. Another investing strategy that can pose high risks for retail investors is “momentum investing.” An investor using a momentum investing strategy seeks to capitalize on the continuance of existing trends in the market. A momentum investor believes that large increases in the price of an investment will be followed by additional gains and vice versa for declining values. If that belief turns out to be incorrect, it can lead to significant losses.
3. Noise Trading. A third related strategy is “noise trading.” Noise trading occurs when an investor makes a decision to buy or sell an investment without the use of fundamental data (that is, economic, financial, and other qualitative or quantitative data that can affect the value of the investment). Noise traders generally have poor timing, follow trends, and overreact to good and bad news in the market.
The Securities Exchanges Have Built In Protections
When a security that trades on a national exchange experiences wild price swings, the national securities exchanges have rules in place to protect against such market volatility. The so-called “Limit up-Limit Down” rules were designed to stop trades in such securities from being executed outside a specified price parameter. This price band is automatically set at a percentage level range above and below the calculated average price of the stock during the immediately preceding five-minute trading period. If the price of the stock should move outside of this price band for a time period in excess of 15 seconds, trading will be paused for a five minute period. The SEC’s measures to address market volatility have been in place for almost a decade.
The exchanges additionally have market-wide circuit breakers. Both the securities and futures exchanges have their respective procedures for coordinated cross-market trading halts should there be a severe market price decline that reaches levels which could exhaust market liquidity. Such procedures act to temporarily halt trading and, under some extreme circumstances, all for the closing of markets before the normal closing time of that day’s trading session.
These circuit breakers provide for cross-market trading halts where there’s been a single day market decrease in the S&P 500 Index. The cross-market trading halt trigger point thresholds are measured in three levels of decline: 7% (Level 1), 13% (Level 2), and 20% (Level 3). These triggers are calculated daily as measured against the prior day’s S&P 500 Index closing price.
Brokerage firms also seek to limit their exposure during market volatility.
One way that brokerage firms seek to limit their exposure is to reserve the ability to reject or limit customer transactions. This reservation of rights is generally disclosed in the investor’s account agreement. Under certain circumstances, the broker-dealer may decide to not accept orders where it believes that the transaction would present compliance or legal risks.
This is what happened in January 2021 when Robinhood restricted trading in GameStop and other stocks amid an increase in their capital requirements as required by the SEC as well as the Depository Trust & Clearing Corporation. During that time, Robinhood instituted restrictions on various stocks and options during a retail investing frenzy in heavily shorted securities which was fueled in part by online platforms.
Market Manipulation Risk of Online Platforms
During the pandemic, fraudsters used the forums online (including social new sites, message boards, online chat rooms, and various stock discussion forums such as subreddit groups) to spread false or misleading information. There is a risk on these social platforms for fraudsters to manipulate a company’s stock price (both to pump up the price or move the price down) and to use this forum to profit at the unsuspecting investors’ expense.
For example, in a typical pump and dump scheme, the fraudster pumps up the stock price of a company through false and misleading statements creating a buying frenzy, and, after the price is high, the fraudster can then sell the inflated shares at a high price. In the inverse situation , the fraudster will begin negative rumors urging investors to get rid of the stock so that the shares plummet, allowing the fraudster to buy shares at an artificially low price.
In order to prevent investors from being scammed, the SEC suggests these long-term investing tips:
1. Understand your investment timeline. Generally, information you read online can be very short-term. Many articles or posts just focus on events that may only have an immediate, as opposed to long-term, impact on investments. Investors should instead focus on their long-term goals, as well as considering the benefit of a diversified account.
2. Follow a specific financial plan. Research has shown that online discussion platforms and buy/sell indicators that are driven by social sentiment might lead you to make investment decisions that are emotionally or impulsively driven. This can be a risky approach to investing. Investors should not let their short-term emotions about investments interrupt their long-term financial objectives. Instead, if you want to participate in short-term investing, consider allocating a small portion of your overall portfolio to this type of investing.
3. Be mindful that investing based on social media posts may be dangerous. While it is true that online platforms may offer some useful investment information, investors should use extreme caution when making their investment decisions solely on information received from social media platforms. Remember, that you have no way of knowing what the motivation is of the posting party—and that it might be to move the stock in a direction which only serves to help the posting party.
4. Don’t feel the pressure to invest immediately. Before you invest your hard earned money, you should research the company thoroughly. Make sure you understand what its business is, and that you carefully review publicly disclosed company information. If you take your time researching before you make any investment, you can protect yourself from securities fraud.
Have you been the victim of Investment Fraud in connection with short-term trading? Our investor fraud lawyers are here to help.
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If you or a loved one have suffered investment losses as a result of investment fraud or broker negligence, contact the offices of Investment Fraud lawyer Melanie Cherdack for a free consultation. Because she has been in the trenches as a former Wall Street attorney, Melanie Cherdack and her team of experienced attorneys have seen just about every type of investment fraud or investment scam. While almost every investment carries a degree of uncertainty and risk, you may have been unnecessarily exposed to such risk. Former Wall Street securities attorney Melanie S. Cherdack and her team of lawyers represent individual and institutional investors who are unwitting victims of investment fraud and broker negligence. She heads up a group of attorneys who represent investors across the United States and the Americas. Contact us by filling out our online contact form, or calling 844-635-1609.