(STL.News) The SEC’s Office of Investor Education and Advocacy warns investors of the significant risks of short-term investing based on social media, especially in volatile markets, and provides tips for long-term investing.
Retail investors may seek to profit from volatile markets by buying individual stock, including stock in heavily-promoted companies with smaller market capitalizations. Some of these stocks may be discussed in social media, news aggregators, investment research websites, online investment newsletters, ratings websites, message boards, chat rooms, and discussion forums. It can be tempting to jump on the bandwagon and follow whatever the crowd seems to be doing. Sometimes, however, following the crowd may lead to significant investment losses.
Short-term trading, including trading aided by the use of margin or options, can lead to significant and unanticipated losses for retail investors. A Library of Congress report identified several investing behaviors that can undermine investment performance, including behaviors that involve short-term investing. Investors should keep in mind these behaviors when considering investing in a volatile market, including:
Be careful investing with margin, options, or short sales.
All investing has risks. If you invest using margin, options, or short sales these risks may be magnified. Margin trading (using borrowed money to buy securities) can be very risky and is not appropriate for every investor. Before you invest using margin consider that:
For more information on margin trading and its risks read our investor bulletins: “Understanding Margin Accounts” and “Margin Rules for Day Trading.”
Options (contracts to buy or sell a stock for a specified price on or before a certain date) like other securities carry no guarantees. Investors should be aware that it is possible to lose all of your initial investment, and sometimes more. Option holders (buyers of option contracts) risk the entire amount of the premium paid to purchase the option. If a holder’s option expires “out-of-the-money” the entire premium will be lost. Option writers (sellers of option contracts) may carry an even higher level of risk since certain types of options contracts can expose writers to unlimited potential losses. For additional information on options trading and its risks, read our investor bulletin “An Introduction to Options.”
Short sales involve the sale of a stock you do not own (or borrow for delivery). Short sellers believe the price of a stock will fall. If the price falls, short sellers buy the stock back at the lower price and make a profit. However, if the price of the stock rises, short sellers will incur a loss when they have to buy the stock back at a higher price. Short sales can expose an investor to the possibility of unlimited losses, since a stock can theoretically keep rising indefinitely. For additional information on short sales, read our investor bulletin “An Introduction to Short Sales.”
The national securities exchanges and FINRA have rules designed to address market volatility in stocks listed on a national securities exchange. The “Limit up-Limit Down” rules are designed to prevent trades in these stocks from occurring outside a specified price band. This price band is set at a percentage level above and below the average price of the stock over the immediately preceding five-minute trading period. If a stock’s price moves outside these price bands for more than 15 seconds, trading in the stock will be paused for five minutes. For additional information on the “Limit Up-Limit Down” rules, read our investor bulletin: “Measures to Address Market Volatility.”
Also, broker-dealers may reserve the ability to reject or limit customer transactions. This may be done for legal, compliance, or risk management reasons, and is typically discussed in the customer account agreement. In certain circumstances, broker-dealers may determine not to accept orders where a transaction presents certain associated compliance or legal risks.
Be aware of the potential for market manipulation on online platforms.
Fraudsters can use online platforms (including social news aggregators, investment research websites, online investment newsletters, ratings websites, message boards, chat rooms, and discussion forums) to spread false or misleading information. Fraudsters may try to manipulate a company’s stock price (either positively or negatively) and to profit at investors’ expense.
For example, in a pump and dump scheme, fraudsters pump up a company’s stock price by making false and misleading statements to create a buying frenzy, and then sell shares at the pumped up price. In other instances, fraudsters start negative rumors urging investors to sell their shares so that the stock price plummets and then the fraudsters take advantage of buying shares at the artificially low price.