How Would the Stock Market Handle Me Doing a Huge Stock Purchase?

July 4, 2004 6:12 PM

The way I understand the stock market, prices go up when people are buying, and go down when people are selling. So what if I had a huge amount of money, bought tons of stocks and then sold them again instantly? Wouldn't I make a big profit? Or am I just completely wrong?
posted by reklaw to work & money (19 comments total)

You need someone to agree to buying those stocks from you at that given price. And if by "huge amount" you will run into beurocratic nightmares if you try and carry out many sales to different people all at once without telling them. And they would want some kind of incentive to pay significantly more per share than you did for you to make a profit.
posted by Space Coyote at 6:18 PM on July 4, 2004

Here's another question about stocks which have always puzzled me:
I buy stock in reclaw, inc., a 100 shares at $100 a share, with that £10,000 going to reklaw (or whoever it was that created the shares). Then, after a certain while, when I've judged that I can profit, I sell them to Space Coyote for $110 a share. I take my profit - $1,000 - but this does not benefit reklaw, inc at all, as those shares did not belong to them. So why do corporations (or, as I live in the UK, PLC's) want their stock to rise? I really do seem clueless as I write this...
posted by dash_slot- at 6:47 PM on July 4, 2004

Most big market makers sell through an institution like a broker. There's no bureaucratic nightmare there in buying or selling a huge block -- they do it all the time -- but you will certainly run into a problem with liquidity, which refers to the supply/demand problems you have buying or selling a huge block of stock.

To answer your question, are you assuming that you will be able to sell them again ("instantly") for more than you paid? The price would have to move up for that to happen, and if you can figure out how to time your trade to take advantage, congrats, you are one of the few and you will indeed become wealthy(er) quickly.

More likely, assuming no outside influence on the price (imbalance of other buyers or sellers), you will run into liquidity issues on both the buy and the sell sides of the transaction. For instance, if MeFi Networks, Inc. is selling at $20, and you go into the market to buy a "huge block" at $20, you will almost certainly wind up paying more than $20 on average for all your shares, as sellers of the different smaller blocks that you will need to buy will raise their price in response to all the transactions you're doing. Your first block might cost you $20, the second $20.10, and so on.

It will work in an opposite fashion as you sell, so it will probably be a wash. And the transaction fees you'll pay your broker will result in a loss. So, assuming no outside price movement, you'll actually lose money doing this.

Most investment management firms, who buy and sell big blocks all the time, have trading desks staffed by people who pretty much wrestle with this problem all the time. If a portfolio manager or a big client wants to get in or out of a stock for whatever reason, they may do the trade over a period of days, weeks, even months, in order to avoid causing the price to move by their own trading behavior.
posted by luser at 6:50 PM on July 4, 2004

dash_slot: For several reasons.
First, as we all saw in the dotcom boom, companies can use their stock as currency, using options as compensation to attract & maintain good people, and also as currency in mergers and acquisitions. The AOL/TW merger is a great example. If I'm going to acquire you, buying you with shares of my stock, I can obviously buy a lot more if my shares are worth more.

Second, the top management of most companies are owners of their companies' shares. So there's that. Also, management is judged on the success of the company, and that's mostly determined by stock price.

Third, a company that's worth more has a healthier balance sheet, enabling it to borrow money more cheaply to fuel further growth.
posted by luser at 6:56 PM on July 4, 2004

luser:
First, as we all saw in the dotcom boom, companies can use their stock as currency, using options as compensation to attract & maintain good people, and also as currency in mergers and acquisitions. The AOL/TW merger is a great example. If I'm going to acquire you, buying you with shares of my stock, I can obviously buy a lot more if my shares are worth more.
But few companies are in that position, maybe 1%? 5%? For those outside that, what is the benefit?

Second... Also, management is judged on the success of the company, and that's mostly determined by stock price.
That's a little tautological. Why?

Third, a company that's worth more has a healthier balance sheet, enabling it to borrow money more cheaply to fuel further growth.
See 'why?'

The only thing that makes sense is that the management have shares. But there are other shareholders - how do they benefit?
posted by dash_slot- at 7:04 PM on July 4, 2004

Ask the Hunt brothers. They tried something similar with silver, buying lots of it to (in part) drive the price up -- at one point, they owned somewhere between a third and half of the known silver on Earth. What happened: the market tanked when people noticed, and they lost something over a billion dollars in a day or so in the late 70s/early 80s (ie, back when a billion was real money).
posted by ROU_Xenophobe at 7:31 PM on July 4, 2004

And if you really want to be scared, read up on naked short selling. Not only does it involve pantsless brokers, but it also involves selling shares that don't even exist, on the hopes that you can drive down the market price to purchase those shares that do exist.

I'm beginning to believe the stock market has become thoroughly rigged against the retail investor.
posted by five fresh fish at 7:58 PM on July 4, 2004

dash_slot: So why do corporations (or, as I live in the UK, PLC's) want their stock to rise?

In your example, the original owner of the company sells the company off to a buyer, who later sells the company off to the third party. Since the original owner no longer owns the company, it doesn't matter what they think. However, the third owner will probably want to sell the company at some point in the future. This explains why the company will remain publicly listed, but the various owner's opinions on public listing may change over time.

More realistically, the original owner(s) typically sell a small portion of the company to the public at an IPO. Anywhere from 10-30% is common. Over time, the original owners may sell shares in to the public market (typically as the share value rises) or buy additional shares (typically when the share price declines). When a small group of owners control nearly all of the company, they may elect to take the company private.
posted by Kwantsar at 8:28 PM on July 4, 2004

dash_slot: Just to add a couple more points to the great points people have made on "Why care about the share price?"

1) Companies actually have a fiduciary responsibility to place the interests of the shareholders first. They have an obligation to act in their tnterests, and the primary interest of most shareholders--especially the institutional ones like investment banks who own most stocks--is in the value of the investment that they made by buying the stock.
Most people don't realize that some of the largest stockholding institutions, by far, are the retirement funds of the larger states. The California fund ("Calpers"), which manages the retirement accounts for all state employees, has billions of dollars invested in stocks, and expects all those companies to act in a way that places its investment value first. (The state funds will occasionally make demands that are less profit-driven, like equal-opportunity employment, etc., but their own basic responsibility is to provide for the retirement of all those state employees.)

2) "Share price" has also become a simple-minded proxy for the success of a company. Regardless of all the stockholder pressures, etc., share price has become accepted as the major indicator of corporate well-being because it is measurable, transparent, and important people (institutional investors) already seem to pay attention to it.
That's not to say it all that it's actually a good measure of corporate health--it's kind of like gauging your personal finances by taking your body temperature--but it's a commonly accepted one that anyone can look up very easily, and so it's become more widely used than it probably should.
posted by LairBob at 9:19 PM on July 4, 2004

To see a graphical illustration of the "prices go down as you sell more shares" phenomenon, check out the Level II quote on this page. the "size" column refers to hundreds of shares that each entity is willing to purchase at the stated price. For example, say you wanted to sell 10,000 shares of Intel. You'd sell the first 7,500 shares at 20 5/8--made up of lots of 4200, 1000, 2200, 100, from Island ECN, ARCA ECN, Instinet, and Herzog. The next 2500 (assuming the maket makers don't feel the volume and drop their prices on you) would probably be routed to (and filled at) the BRUT ECN (who offer to buy 3000 shares, you may choose to sell fewer) for 20 9/16, or otherwise further broken up to the ECNs and Market Makers who want to pick up smaller lots.

(It's worth noting that the example I provide-- 10,000 shares of Intel-- is, as block trades go, very small potatoes. A larger share quantity and/or a less heavily traded stock would have much more pronounced price movement. In the example, the bid/ask spread is a paltry sixteenth (and, with decimalization now the norm, still larger than you're likely to see for such a firm). For a smaller, less oft-traded firm, the difference between the bid and the ask can grow to 50 cents or more. Over hundreds of shares, it really adds up. That's how market makers make their money.)

If you look at the other side of the picture, you see that the corollary happens to the buyer. Buy more shares-- prices go up.

I once heard a trader refer to this (perfectly reasonable, natural, and fair) occurence as the "Janus Effect", because that well-known fund firm was playing with momentum during the tech bubbles hayday. Janus would own Juniper Networks, the stock would have a good pop, people would send checks to Janus, who bought more Juniper, which would drive the price up, attracting more checks, et cetera. Unfortunately, this same effect works on the way down. Tech stocks suffer, janus has to sell Juniper, drives the price down, people ask for checks, sales of Juniper drive the price down, et cetera.

As an aside, it's worth noting that a Mutual Fund may own only ten percent of a particular company's outstanding shares.

The simplest explanation of why corporations want their stock price to rise is because stock price+ number of shares = value of firm. Managers are paid to grow the value of the company. Would you rather own a lemonade stand or all of McDonald's?

five fresh fish: I think that you're dead wrong. First of all, shares sold short do exist; and they are borrowed only from institutions and people who have signed margin and hypothecation agreements. Don't want your shares borrowed? Hold them in certificate form, direct registration, or a cash-only account. Short sellers are important. They make markets more efficient, and they permit savvy investore to profit from a drop in share prices. Furthermore, short sales may not occur on downticks, so they are not responsible for catalysing big selloffs. And the markets aren't rigged against anyone. The average retail commission has plummeted over the past thirty years. Retail investors get the same quotes and the same executions as the big boys. The market may be rigged against dumb money, but then, what isn't?

I'm not being a Randite here, either. I think that you'd be very hard pressed to find a finance or economics professor who agrees that the markets are rigged, or that short-selling is dangerous, scary, or unhealthy for the markets or the economy.

As I preview my post, I realize that my answer isn't as clear as I'd like it to be, but it's awfully late. My email is in the profile if you need clarification and don't want to post it here
posted by trharlan at 11:45 PM on July 4, 2004

trharlan, regarding the fairness of the market, I think there's a big difference between the fairness of the underlying market mechanics and the way that market participants actually conduct themselves. I think you're right in rebutting fff's point on the broader market--I don't believe it's rigged--but having had close involvement in a few IPOs, and worked with a bunch of investment banks, the retail buyer is definitely given the short end of the stick, on purpose, on a regular basis.

Just look at the typical boom IPO (which is coming back). Institutional investors and "friends and family" (what a joke)--get to buy and flip before the general public has any meaningful access to the shares. The same shares may go through two or three buys and sells on the very first day, all within the inner circle of folks who know they can offload it to the next "rung". Investor "A" buys the shares for the offering price (say $10), and sells it to B for $20. $B gladly buys it at $20, because he knows he can sell it for $30 to C. C sells to D, etc., until F finally dumps the shares on an eager, uninformed (or misled) market at $90 or $100. All the investors who are on the offerings books have made money from the escalation, and the retail investor is the sucker at the end of the line who gets the "opportunity" to buy the shares once they've gotten overpriced.

Granted, that's a very specific, controlled example, but it does typify how the retail buyer is very often the required patsy, who has to be part of the larger picture for a lot of deals to work. The individual transactions may all go through a relatively fair, objective process, but the overall culture has spent a lot of years being very clever about how to take advantage of a less-informed retail market.
posted by LairBob at 7:33 AM on July 5, 2004

Would you rather own a lemonade stand or all of McDonald's?Well, all of McDonalds. But no individual does, do they.

I'm not being picky or snarky - I'm looking for an explanation that holds water. That one doesnt, but the incentive for managers makes sense, up to a point. Also, withholding shares from the market till value goes up, or issuing new shares at opportune moments - that makes sense. But it's still true as shares rise and are sold, the shares in circulation in the market do not return a value to the corporation.

Also, a business's market capitalisation is a kind of notional idea: would I prefer - or profit from - owning 100% of a lemonade stand, or 1/1,000,000th of McDonalds? I'm not sure to be honest. One is an occupation, one is ownership of propery. Capitalism changes things.
posted by dash_slot- at 10:26 AM on July 5, 2004

Companies actually have a fiduciary responsibility to place the interests of the shareholders first.

Which is actually a pretty big problem these days. An overfocus on short-term profitability is creating situations in which employees, environment, and long-term viability are given short shrift.

Naked Short Selling: "In a short sale, an investor borrows shares and sells them on the open market, hoping to buy them back after the price falls and replace them for a profit. In a naked short sale -- a tool that organized groups of traders use to manipulate the market -- a large amount of shares that do not exist are sold to a market maker in the stock on the exchange in the hopes that the sale will create downward pressure on the price before the regulated time span for actual delivery of the stock (usually three business days). Then, after the share price declines, real shares are purchased and transferred to the market maker."

In naked shorting, the shares are NOT "borrowed only from institutions and people who have signed margin and hypothecation agreements."

They are a manipulative method of driving the share price down by causing panic, so that the naked shorters can grab the shares cheap and profit on the subsequent rebound.
posted by five fresh fish at 10:28 AM on July 5, 2004

In naked shorting, the shares are NOT "borrowed only from institutions and people who have signed margin and hypothecation agreements."

Well, fff, I was unfamiliar with naked short selling-- probably because it's illegal in the US. So I should have qualified my statement to have read, "If you are a US citizen, holding shares of a domestic company in a cash account, in DRS, or in certificate form, your shares cannot be sold short."
posted by trharlan at 11:28 AM on July 5, 2004

Let's try this again from a different angle: Corporations don't "want" their stock to be valued as richly as possible. Corporations are a legal abstraction; they want nothing. The owners of the corporation want it to be valued as richly as possible (for the same reason you want your house/ baseball cards/ coin collection to go up in price) because they want to be able to sell it for a profit.

The reason that the board and the management of the company want the share price to go up is that their bosses (the shareowners) will reward them for a rising share price and punish them for a falling share price.
posted by trharlan at 11:40 AM on July 5, 2004

A-ha, it's beginning to dawn on me - your last paragraph helped. I just don't think in those terms, that people in abstract relationships some distance from one another actually 'punish' each other. But I s'pose it's what I do at election time, so Hey! It's all good.
(I sometimes wonder, "am I too naive to be let out on my own?")
posted by dash_slot- at 12:22 PM on July 5, 2004

Try again, harlan. The Berlin-Bremen Stock Exchange is listing hundreds upon hundreds of American stocks without the permission of those American companies, who have exceedingly little recourse should they wish to be delisted. And the BBSE allows naked short selling.

So while you may have made sure the stocks you possess can not be shorted in the USA, there's every possibility that the company's stocks are being naked short sold in the BBSE in an attempt to devalue the stocks you possess.

Naked short selling makes us all vulnerable, and there doesn't appear to be a lot we can do about it yet.
posted by five fresh fish at 1:17 PM on July 5, 2004

I see our disconnect here, fff. I'm stating that if I hold the shares under the conditions I list, my shares are not at risk.

I think that you're implying that naked shorting on foreign exchanges creates substantial price volatility in domestic markets. That's an interesting theory. Do you have any evidence?
posted by trharlan at 1:52 PM on July 5, 2004

Er, as long as you don't sell your shares, your shares aren't at risk, ne pas? I don't think any amount of shorting can force you to sell your shares to the shortee.

But the shorters can manipulate the market to drive the price down. That's where you can be affected: if naked short sellers manage to drop the value by 30%, what are you going to do... continue to hold, or sell for a loss?

Anyway, there's been quite the hullabaloo about the BBSE lately. It pays to be aware of stocks that are listed on it, if only because the market is going to treat those stocks as threatened, even if in reality they are not going to be harmed.
posted by five fresh fish at 4:59 PM on July 5, 2004