Terry Zink's Cyber Security Blog

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Dow Theory and stock spam

Dow Theory and stock spam

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One of the things I do in my spare time is trade stocks on the stock market.  With all of the stock spam we (ie, customers) receive I wondered if there were any applications to the market and market theory.

Something I have learned about in the past two years of trading is Dow Theory.  Dow Theory has six theorems and I would agree with all of them.  I won't go into the full theory here, but I want to allude to theorem 6, that "trends exist until definitive signals prove that they have ended."

Stock spam attempts to sucker investors in by preaching that a certain penny stock is about to explode.  The spammer has shares in the company and when the general public plows their money into the stock, the price of it shoots up.  Since penny stocks are highly illiquid and cheap, investors figure they can buy a lot of shares, wait for the price to go up and then get out at the top (since the stock is about to explode).  This never works for a couple of reasons.

First, it assumes that investors actually will get out after they have increased their money after a short period of time.  Personally, I find it incredibly difficult to get out after a quick profit because I find myself always wanting more.  I find it extremely doubtful that people who buy stocks from a pump and dump stock scam actually would have the personal discipline to get out quickly, because if they really were disciplined they would not have gotten into the stock in the first place.

Second, and this is the real problem for investors, it assumes that they actually can get out quickly after the price shoots up.  Penny stocks, as I said above, are highly illiquid.  These means that it is difficult to get one's money in and out with driving up or down the price of the stock.  If a person buys 1000 shares of a stock that normally trades 100 shares per day then when they get in, they will drive the price up.  When they get out, they will drive the price down.  It's a losing proposition in both directions.  What's worse, they may even have trouble liquidating their positions.

How this fits into Dow Theory is that one of its corollaries is that manipulation of the long term trend is impossible.  According to Dow Theory, there are three trends - the first is the short term trend, lasting days to weeks.  The second is the intermediate trend, lasting weeks to months, and the third and most important trend in the primary trend, lasting months to years.  While it may be possible to manipulate the short-term trend and maybe even the intermediate trend, the primary trend cannot be manipulated.

What this means for penny stock investors is that if you pile into a stock and the price shoots up, as soon as that demand goes down the stock will go back to where it was before everyone piled in and resume doing what it was already doing.  If the stock was moving no where for years, it will go back into the trading range and resume going no where for years.  If the stock was in a down trend it will retreat back into the down trend.  Hoping for a big pop and then getting out may prove difficult, and holding on for the long term is an even worse proposition.  Do not buy stocks in stock spam; it's pretty much guaranteed not to work.

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