Speculators welcome too!

A file photo taken on December 3, 2007 shows policemen standing guard in front of Dhaka Stock Exchange building after hundreds of general investors took to the street when a key index lost 83 points at one stage on the bourse. Photo: STAR

A stunning blonde in a sharp business suit was announcing an early session rally in the DJIA (Dow Jones Industrial Average), the benchmark index for US markets, as I turned the tube on to CNN on a Monday evening few weeks back. The rally, as the blonde continued, was driven by a rising General Motors (GM) stock, a major component of the DJIA, on announcement of FY2007 financial results. Most of us would assume, naturally, bumper profits in 2007 pushed the stock higher. But actually not so, GM made no profit rather a staggering US$ 38.7bn loss in 2007, the largest in the history of the auto industry! So why is the stock going up on heavy volume?
Economic fundamental is one of many factors that affect stock prices in the secondary market. As a matter of fact, in emerging markets such as ours, the major determinant of stock price is basic demand and supply. The reasons fundamentals do not play a major role in our market are: a) absence of any quality research; b) lack of transparency, c) poor corporate governance and disclosure, and d) an insignificant asset management industry. Therefore, with supply and demand being the major determinant, more often than not, stock prices deviate sharply from fair value.
Individuals and institutions trade financial securities to profit through investment and/or speculation. That is why all standard exchanges in the world allow short-selling, a technique in which a trader borrows shares and sells them hoping to buy them back at a lower rate before he must return them. They also encourage the use of derivatives, such as options and futures. These instruments are not just tools for speculation but an essential part of the market system that work as automatic stabilisers in times of volatile or abnormal trading, and as risk management tools for hedging. For example, large position taken by short-sellers or an increase in the premium of “put” options give the market an indication that price of the underlying security may have reached unsustainable heights, and consequently result in a correction closer towards fair value. The opposite is also just as applicable.
Unfortunately Bangladesh's Securities and Exchange Commission finds short-selling to be evil, and vows not to discuss it ever. Instead, they prefer structural changes to stabilise volatile market conditions. These moves by the SEC, usually as a late reaction to an over extended rally, produce nothing more than an angry demonstration by the traders and the immediate reversal of the proposed move by the SEC. They are yet to realise that controlling market direction is manipulation, and their job responsibility calls for the prevention of this act, not the practice of it.
It is impossible for stock prices, or an Index for that matter, to continue in one direction indefinitely. If everyone thinks the market is going to go up, then there would be no sellers, and vice versa. There would be no market at all! Besides, why would an entrepreneur risk venturing into other businesses if buying stocks were guaranteed to be profitable! People who trade in developed markets are expected to be aware of the risks associated with speculative trading, and that is why they don't protest outside the exchanges, even in the event of a market crash!
“Buy Low/Sell High” is not the only way to profit from trading financial securities. Modern exchanges offer profit opportunities under various platforms and in any direction prices may move. It is time for stock traders, the exchanges, and the SEC to recognize the risks associated with securities trading, and the importance of short-selling and derivatives in the context of an overall market mechanism. A transparent stock exchange that allows short-selling and the use of derivatives is self-correcting, and therefore requires no outside intervention. It will also offers multiple opportunities to profit at all times, and irrespective of market direction.
Oh! The reason GM stock surged that Monday morning was short-sellers, anticipating a loss even worse, beat the stock price down to a level reflecting the market expectation of US$ 50bn loss for 2007. The stock started to move upwards, on demand from “bargain hunters” and speculators on the long side, as the price was below fair value considering the actual loss of $38.7bn. The frenzied buying by short-sellers, in a desperate attempt to acquire shares they sold before, boosted the stock price, and consequently pushed the DJIA, even higher.

The writer is an Independent Financial Consultant, Investment Adviser, and a Lecturer, School of Business, IUB
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