Shorting before going long
How common is it for hedge funds, or other large institutions, to short a stock in an attempt to drive its price down before going long? Particularly a stock with lower volume where it can have more of an impact.
Asking because I believe this is the currently the case with a stock I am interested in, however, if this is a very rare practice then I want to reconsider.
Not common, not only impractical but also potentially illegal.
I am no SEC expert, but I think that would be considered market manipulation and if you are moving the market, you'd be raising some flags with your outsized volumes.
Secondly, illiquid stocks are hard to borrow and short. You have to get a borrow from a broker before you short, otherwise it'd be naked short selling which is illegal.
Lastly, if you could short in enough size to move the market, you then have to buy to cover in order to be at a net neutral position. That's before even buying in order to establish your long position. So unless you could short in size and create enough fear that REALLY pushes the price down, your covering will likely get the stock right back to where it was. Net, you'd end up paying a lot of commissions.
So yes - I would think it is very rare.
If it's lower volume, you generally would need to short en masse with an absence of buyers to really move the stock, unless we're talking about a very, very thin penny stock. When you bought back in to cover the short, you would effectively be long, and would likely drive the price back up (you're basically just trading with yourself). To complicate matters though, if you really did move the price enough to generate some kind of net profit, you might easily attract momentum traders who look for stocks "in play" that would exacerbate the move back up.
As Kenny said, not practical in most cases.
Contrary to popular belief, there isn't that much price manipulation outside of the thinnest of the thin microcaps, unless you consider quant funds to be price manipulators, but that's a different discussion.
The other kind of going short and going long is a legitimate strategy though as prices sometimes significantly overreact. I was short TPX at $82, covered low $20s, and then went long at $25, but that had nothing to do with manipulating the price, it's far too large and liquid. There's no reason you can't play both sides.
Do you guys really think market manipulation is that unusual? I am not necessarily contending that it isn't, I'm more so just curious. It just seems the SEC really isn't much of a deterrent and there has been some pretty prominent examples in the past, ie JPM- Silver market
Funds will often do the opposite when they think they won't be able to get a borrow later... aka shorting against the box? But yeah, shorting with the sole intent of lowering the price and forcing capitulation so you can cover and then go long is clear market manipulation. I'm sure it happens but probably isn't worth it most of the time...
Heard of it in very large, very liquid stuff (like HPQ, you would have made a killing doing this recently). There are execution issues and potential legal issues in doing it in anything illiquid. But more realistically, you could have an alpha short as half a pair, get convergence and then decide you like the upside on the short at that price, take profit on the long and flip over your short to a long.
TPX was a merger arb though, that's different - binary outcome and if your opinion changes then your position flips.
It wasn't different, it was an obvious short on competition and slowing momentum, and it was an obvious long on the flip side with easy comps coming, improving industry conditions, and a cheap stock. I love stocks that gap down 3-4 times in a row over a short time period but aren't going to zero. I couldn't care less about the merger and had no view on any "arb". Merger arb is a gay strategy anyway -- cool, let me speculate on some binary outcome where my edge comes from inside information, no thanks.
Agree with your merger arb is scary and not profitable enough to be worth doing these days. Also, thesis makes sense, I just didn't know there was that much going on there beyond industry consolidation/competition and the merger.
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