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Safe to Buy Stocks with Little or No Float?

26 May 2014


Someone has been selling on the idea when there is very little float,  for example in the case of China Fishery Group Pte Ltd (CF,  BOZ.SI) in SGX,  there would be little chances of prices falling drastically should there be a sell down;  it is pretty safe to buy and keep so to speak.  Let examine a scenario how things can always happen when everyone is complacent.  That is usually how the contrarians will profit. 


Security Lending and Borrowing 


Like most major bourses in the World,  SGX allows also security lending and borrowing.  This is done through the Central Deposit Pte Ltd (CDP) that keeps the registries of all stock and shares traded in SGX.   Any member of CDP can lend and borrow any amount of a particular stock exceeding a minimum lot  provided there are agreed lenders and borrowers.  The script lenders will get 4% interest which is  better than nothing sitting pretty in the CDP’s vaults.    Once lent out, the lender will temporarily lose the ownership of his scripts although he still has all the rights such as receiving dividends, voting and other rights.  The borrower who becomes the temporary owner of the scripts will pay 6% for the borrowing.  He  can do anything with the scripts such as for “covering” its risk in a margins trade or for shorting purposes.  Under the agreement,  the lender can still sell its stocks and CDP will make separate arrangement to cover until the period of the "loan" is over.

Margin Trade


Margin Trade is like borrowing money from a broker or an institution such as a bank to purchase stocks. It can be treated as a loan.   Margin trading allows one to buy or sell more stocks than one can possibly own using the normal channels. They will need little capitals because of the leverage,  sometimes,  can be more than 1 to 10; in other words,  one can buy $10/= worth of stock with just $1/=.  Margin Trades are governed by laws structural wise but not in the actual trades.  One must have the qualifications to become a margin trader and the brokers or institutions will need to comply with some rules and regulations.   In a way,  Contracts for Differences ("CFDs")  is one derivative of margin trades.

 A Possible Scenario


Trader A,  a prominent business man,   thinks that CF is a good stock and it will move up but he could get little through the normal channel because not much was traded in SGX daily due to very little float.  He goes to his brokers or his banks.  Because he is a big customer who can back up his  “loan  of shares” with his collaterals or cash deposits,  the brokers allow him to purchase the stock on a margins trade.  

Assuming CF went up daily,  Trader A will make tons of money because of the leverage.  There will be no top ups required for his margins trade and he can withdraw some of his winnings.  Assuming CF went down,  Trader A will be asked to top up the margins.  Now further assuming that Trader A could not do the top ups in time,  the brokers will have to right to “call” his margins trade with the brokers recovering the cost from Trader A.

Now,  one may ask how do the brokers “call” the margins.  You guess it right.  Besides threatening to confiscate Trader A’s  collaterals,  the brokers can also through some means,   taking the opportunity to “short sell” CF using  the borrowed  scripts.  They can always sell CF  in a Zombie way (selling without feeling of losses),  making “a pile” while Trader A will be footing the final bills.
 
 
 
 
 


Characteristics of Zombie Sale

 
Besides these zombies sale has no feeling of losses,  the brokers and institutions are also not in a hurry to buy back and return the scripts.  It will usually take a long time before the price can rise again.

 

Catching the falling knife


It has become an even better ground for the brokers to short sell the market using borrowed scripts when SGX started clamping down the short sellers.  First, they said one cannot short-sell without covering within the day; otherwise, the buying-in will start on T+2.  Then, they modified later to say one can short-sell but must cover within T+3.  The buying-in by CDP will start at T+4.  

Either way, greedy investors now turned to CFD or margins trading where investors are allowed to buy or short any amount within the scope of  “limited funds and collaterals ”.  These are all performed and controlled by the brokers and Institutions. 
 
When the brokers and Institutions started making margin calls and afterwards, short selling the market,  it will create a falling knife pattern where many retailers will trade for profits by buying at low,  then selling at high.  How much will these retailers profit will depend on when the brokers and Institutions will complete their zombie sales.

The final winner is none other than the brokers and the Institutions as they will have the  control of the market and also enough collaterals to cover the damages and losses.  The retailers who rushed in to buy up the stocks think it was a bargain might contribute more to their winnings .
 
 

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