by: Mike Gallop
Front-running. Pump-and-dump.
If you have never heard these investing terms, that makes perfect sense, because you are not a licensed investment advisor. As an advisor, we have regulations and compliance set by FINRA, the SEC, state securities regulators, and our Broker/Dealer, SagePoint Financial. All of our personal investment accounts are monitored to ensure we are not engaging in any financial shenanigans. This is all CYA for you, the client, and us, as a business. Compliance can be tedious, and yet is an absolute necessity in our industry.
Front-running: the trading of a financial asset by a broker who has inside knowledge of a future transaction that is about to affect its price. It's a scam.
Pump-and-dump: a scheme that attempts to boost the price of a stock through recommendations based on misleading statements. It's illegal.
But here’s the thing: if you are not a financial advisor, these rules don’t apply. The retail investing public gets stock tips from friends, family, social media, TV--anywhere, really. The question you need to ask yourself is, why? Why is someone sharing this “great idea” with you? What is the motive or incentive? I’d love to think that everyone sharing investment ideas is doing so out of the goodness of their heart, but color me a skeptical New Yorker.
In the last year we've seen several asset bubbles, and I believe a huge reason for this is the rise of day trading combined with a social media addiction exacerbated by the COVID-19 lockdown. People are online more than ever, and FOMO (fear of missing out) is a real phenomenon. Investing has become a national pastime in the last 12 months, which is both encouraging and horrifying all at once. Investors of all shapes and sizes are buying investments, and then shouting at the rooftops to anyone willing to listen that said investment is the best thing since sliced bread. They want you to invest in the same asset, and hope you tell everyone you know about the money people are making in that investment. Sound familiar? Multi-level marketing!!!
Example #1:
A twitter influencer with 3 million followers takes a large position in Apple stock on Monday. On Tuesday, they tweet how awesome Apple is and how everyone should buy Apple stock. A percent of their followers listen to the advice, and all go buy shares of Apple. If thousands of people buy the same stock on a given day, what happens to the price? Yep, those AAPL shares bought on Monday sure look like a good deal now.
Example #2:
A huge family gets together for the holidays, and the Millennial nephew is touting the future of Bitcoin to all of his older relatives. He mentions companies utilizing blockchain technology, inflationary issues with the dollar, and how much money he has made holding Bitcoin since 2015. He hopes his relatives buy Bitcoin, and tell their Boomer friends to get on the bandwagon as well.
Now, maybe these people are sharing knowledge with good intentions, and just want their followers/loved ones to make money. The problem is the incentive to drive the demand for an EXISTING investment is obvious and powerful. It brings greed into the equation, which is always a dangerous aspect of investing. It’s impossible to give a rational, unbiased opinion on an investment when you have a vested interest in that investment going up in value. We are emotional humans; not robots or algorithms. This is why licensed financial professionals cannot engage in these activities; it would be completely unfair and unethical for me to buy a stock and THEN buy it for all of my clients, as the increased demand in the stock would most likely ensure that I make money ahead of my clients. No Bueno!!!
There is nothing wrong with sharing or receiving investment ideas, just remember that the other party may have an ulterior motive. I know we are small fish in a giant investment pond, but this last year has proven that the multi-level marketing approach to investing can work in the short run. Gamestop, Bitcoin, sports cards, residential real estate--hopefully these bubbles don’t end too painfully, and I am fascinated to see how it plays out. But please remember, the next time you give someone else a stock tip, they might tell two friends, and they tell two friends….and they tell two more…..
Opinions expressed here are those of the author and are not necessarily those of SagePoint Financial, Inc.