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Stock Price Manipulation – Pledging of Shares Is The Key Culprit

To begin on a lighter note. Stock Price Manipulation is like an extramarital affair. It exists, everyone talks about it but if you ask someone then no one admits :). Similarly, you may find news reports on Stock Price Manipulation but as such, there is no evidence or proof of the same. Recently, one of the news articles that caught my attention was “Pledging of Shares by promoters in the NSE listed companies is at 7 years high”. As a layman stock investor, i read the news but could not find anything alarming. Maybe the newspaper didn’t want to create any sort of panic. I re-read it after wearing the hat of personal finance, i found this news very alarming. Unfortunately, no one explains the real truth. Let me take the credit for the same :).

Pledging of shares is at 7 years HIGH when the stock market is near all-time high means perfect cocktail is prepared for Stock Price Manipulation in future. This is especially true if the pledging of shares is above 50% and floating stocks are low i.e. no of stocks available for trading is LOW. Welcome to the world of Stock Price Manipulation. Before we proceed, it is important to understand the Pledging of Shares.

What is Pledging of Shares?

I was born and brought up in North India. From the childhood days, i listened to a term in Hindi “Girwi Rakhna” from my friends from business class. They used to tell “Mere father ne apni factory Girwi Rakh Di”. It means his father has pledged the factory to raise a loan for the business. This term is very common in business class. As such there is nothing to worry. After few years he told that his father repaid the loan and released the factory. Happy ending !!!

Similarly, Pledging of Shares means the owner/promoter of the company pledges their shareholding in the listed company as a collateral for raising a loan. This is an alternate form of raising the funds. To raise funds for the expansion of the company is good. On the other hand, if the funds are raised to provide an exit route to the promoters/investors then it is a bad sign for retail investors. I highlighted this in my post, 5 Reasons Why you should not invest in an IPO or Initial Public Offer.

The “pledging of shares” activity increases when the stock market/stock price is on a rise or near the peak. The promoters can get a higher loan. Assuming, a stock market operator/broker is willing to offer 70% of the stock price as a loan. Balance 30% will be his returns or hedge against risk. When the stock price is Rs 100, the promoter will get Rs 70 as a loan but if the stock price is Rs 200 then promoter will get a loan of Rs 140. It explains why the pledging of shares is 7-year high because the stock market is near its all-time high. Normally small or mid cap companies raise fund through pledging of shares if they fail to do so through other conventional ways. As such companies don’t need any regulatory approval for the pledging of shares. In certain cases, pledging of shares is a vicious cycle. We will discuss later in the post.

The field is READY for Stock Price Manipulation

As i mentioned that if pledging of shares exceed 50% and floating stocks are low, these 2 conditions make the stock vulnerable to stock price manipulation. Sometimes it is a nexus between operators/brokers and lenders. The operators/brokers identify such stocks and stock price is hammered by the operators/brokers to lower levels. In one of my future posts, i will discuss how the stock price is hammered by stock market operators in such a scenario. This hammering will have a ripple effect. The retail investors and FII/DII (if any) will start dumping the stock. One of most popular sidhuism fits best in this situation. “The way Indian wickets are falling reminds me of the cycle stand at Rajendra Talkies in Patiala…one falls and everything else falls!”

A sharp drop in stock price will make the lenders jittery. For example, If stock price was Rs 100 and lender offered Rs 70 for the pledged share. The lender will not PANIC if the stock price is above Rs 70. What if stock price fall below Rs 70. The lender will be in a LOSS. He will ask promoters to either pledge more shares or return some money so that he can maintain the margin. Because of this reason i mentioned that it is a vicious cycle. Therefore, the promoter will be forced to either pledge more shares or provide funds to compensate for the loss of the lender or maintain margin.

Now imagine if the promoter/borrower is not able to arrange for funds or pledge additional shares then the panic selling will start. Lenders will start dumping the shares to limit the loss and the stock will hit the lower circuit. Co-incidentally such stocks are favorite trading stocks. This is one of the reasons why i always suggest that you should never buy a stock that hit either upper or lower circuit.

Unfortunately, there is a misconception that only the stock hammering means Stock Price Manipulation. The reverse is also true. There is a strategy of pump and dump. The Stock Price Manipulation takes the stock price to new highs. The operators/brokers short sell the stock at a high level and then the stock is dumped to book profit. Therefore, you should avoid stock market tips as i shared in my post, Stock Market Tips – Business of Selling Dreams. These stock market tips are basically a part of pump and dump strategy.

Misconception – Only the Small/Midcap Stocks are Vulnerable to Stock Price Manipulation

This is the biggest misconception that large cap stocks cannot be manipulated. Sometimes they are the indirect victims of stock price manipulation. For example, brokers/operators are planning for stock price manipulation of Stock A (a small cap stock). As i mentioned that they need margins for stock price manipulation. It might be sheer bad luck of the investors of Stock B (Large Cap stock) that brokers/operators take margins of Stock B to manipulate Stock A.

In this scenario, assuming brokers/operators fail in their plan to manipulate the stock price of Stock A. They will start selling Stock B that was put up as margin against Stock A. There will be a sudden collapse in the price of Stock B. Now remember the ripple effect i discussed earlier. The retail investors and FII/DII will start selling Stock B that is basically a technically & fundamentally strong stock. Therefore, Stock B becomes an indirect victim of the Stock Price Manipulation planned for Stock A.

Words of Wisdom:

Stock price manipulation is a chain. The “intelligent” stock market experts or financial planners will never suggest retail investors invest in stocks of highly leveraged or high debt companies. The possibility of a stock price manipulation is high in such scenarios. The probability of stock price manipulation increase when the market had a good run and stock market crash/correction is looming large.

Sometimes the stock price hammering is not intentional but may trigger stock price manipulation as a result of some bad news or financial results. In such cases also lender will ask promoter to pledge more shares or seek funds to maintain margin. To be honest, there are a lot of permutations and combinations.

Retail investors should avoid stocks wherein the pledging of shares by promoters/investors cross 50% and trading volumes are low. In my next post, i will share how to find out the stock price manipulation in a stock.

Copyright © Nitin Bhatia. All Rights Reserved.

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