The stock market is a popular investment choice and the value of stocks owned by investors is more than $15 trillion for the two main stock exchanges located in the U.S., according to the World Federation of Exchanges. For many individual investors there are some good reasons to not be invested in the stock market. Understanding the disadvantages of stock market investing will help an investor decide if the market is the right choice.
The stock market subjects investors to high levels of volatility. This means sometimes the market goes up and sometimes the market goes down. Investors do not mind volatility to the upside, but downward volatility can damage wealth. For example, when the stock market dropped in July 2008, the market lost over half its value in less than a year, as indicated by the S&P 500 stock index.
Not Suitable to Provide Retirement Income
An individual at retirement age may not want a large proportion of retirement assets in the stock market. A retiree needs regular income and many stocks pay little or no dividends. To provide money for living expenses, shares of stock would have to be sold, reducing the portfolio and incurring commissions. Also a major drop in the market will reduce the total capital the retired person has to generate income. Since a bear market–defined as a time when security prices are falling–comes along on average every six to eight years, having most of a person’s retirement assets in the stock market will eventually lead to some tight finances.
A large Number of Choices
Investors that want to invest in the market may be discouraged by the large number of choices. The Wilshire 5000 stock market index covers the entire U.S. stock market and includes over 6,000 stocks. There are over 4,000 stock mutual funds. It can take a lot of time, education and effort to research the market and select an appropriate stock portfolio. The size and complexity of the stock market makes it difficult for an individual investor to successfully meet investment goals.
Risks of Ownership
Owning stock is owning part of a corporation. If the corporation declares bankruptcy, the owners or shareholders are last in line to receive any proceeds from the corporate breakup or reorganization. In most cases if a company goes bankrupt the shareholders receive nothing for their shares. Very large and well know companies have gone bankrupt. The list includes General Motors in 2009, Lehman Brothers in 2008 and Enron in 2001.
How Stock Market Manipulation Works
While there are an infinite number of variations, there are a few common market-manipulation schemes:
Pump-and-dumps are the most common schemes to directly ensnare the average investor. They involve small companies, called “microcaps” or “penny stocks,” with shares that are traded over the counter (OTC). Companies that are traded OTC don’t have to meet the strict listing requirements of an exchange like the NYSE or Nasdaq. Fraudsters use microcaps for their schemes because there is usually very little public information available about the businesses, and it’s easier for them to gain control of the stock.
When fraudsters have control of a company’s stock, they begin a coordinated campaign to promote or “pump” it. The campaign uses social media, emails, fake analyst reports, phony trades, and telemarketing to spread misinformation and create demand. Once the stock price has been inflated, the fraudsters dump their shares. The campaign ends, the share price drops, and legitimate investors are left with worthless stock.
Pump-and-dump promoters often capitalize on pressure sales tactics or news-based recent events to reel in unsuspecting investors.
In 2020, the SEC charged a California-based trader who had made misleading claims on an online investment forum about biotechnology the microcap company Arrayit Corporation, including claims that the company had developed a blood test to detect COVID-19. The trader held a large number of shares in the company and planned to sell them as false claims encouraged other investors to buy the stock and drive its price up. The trader was able to make a gain of $137,000 in six weeks before the SEC suspended trading in the shares of the company.
Wash Trades and Matched Orders
Wash trades and matched orders are forms of fictitious trading. Wash trades are simultaneous buy and sell orders for the same number of shares and share price by the same party. There is no change in ownership, and there is little or no financial risk to the trader. Matched orders are prearranged trades between a buyer and a seller for a set number of shares at a set price.
Wash trades and matched orders are often used in the “pump” phase of a pump-and-dump scheme to create the appearance of a legitimate trading volume.
Spoofing is another form of fictitious trading. It involves placing large numbers of buy or sell orders and cancelling them before they’re executed. In 2020, the Commodity Futures Trading Commission (CFTC) fined JP Morgan Chase $920 million for placing hundreds of thousands of commodity futures orders over eight years with the intent of canceling them before execution in order to influence prices.
Marking the Close
Marking the close is a high-volume trading scheme. Large numbers of trades are placed at the end of the day, artificially driving up the closing price of the stock. In 2014, the SEC fined trading firm Athena Capital $1 million for systematically placing high volumes of trades in thousands of Nasdaq stocks in the last two seconds of the session over a six-month period.