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First of all, there is no such thing as a free market, certainly not in the capital markets. There are mountains of regulations covering stock, options, future

First of all, there is no such thing as a free market, certainly not in the capital markets. There are mountains of regulations covering stock, options, futures, and debt trades. Trading is routinely halted on various securities in extreme circumstances. Insider trading is restricted, and the restrictions become more significant for higher level management. Companies are required to report certain information to the public. Markets exist to solve problems of valuation and capital allocation. Pump-and-dump schemes distort valuations in very extreme ways and work against the purpose of equity markets. That is a basic reason why they should be banned. Another reason is that scams introduce unnecessary risk to someone making an investment decision; ideally investors should only focus on risks related to a company's business, not the risk that the information they were given about that company is false. The extra risk will drive away investors and the result will be less capital available to otherwise promising ventures, which again works against the goals of capital markets. It is not really possible to restructure markets in a way that would avoid pump-and-dump schemes, because the problem with a pump-and-dump scheme is not actually related to the rules governing the market. The problem is that the pump-and-dump scheme involves deliberately spreading false information; yet it is equally possible that investors hear true information and rush to buy, and the market should allow for that situation.

dheera 6y ago
I guess my main question is, why does the stock price go up if mountains of people suddenly buy a stock? It's because we base pricing based on a simple free market order book algorithm. If the markets enforced a pricing algorithm that included certain time-based functions instead of basing it purely out of the order book, and mandate that all transactions happen at the algorithm's determined price (instead of the free market price), a lot of problems including pump-and-dump schemes and insider trading could be theoretically eliminated. We could completely legalize insider trading, for example, if we technologically mandated that large orders took weeks to execute while single shares traded in milliseconds. (I'm an engineer, not a financial expert; I view this problem as very similar to e.g. API limits and firewalls that implement rules to prevent abuse.)
- betterunix2 6y ago
  "The price" is just a convenient way to talk about the theoretical "value" of a company. Brokers use it to determine whether or not margin maintenance requires are being met, but in reality there is no single price at any given time. There are always two prices, the highest bid and the lowest ask, and those two prices are only meaningful for the size of the bid/ask in the order book. How would an algorithm determine the price? The whole point of the equity markets is price discovery. The price should rise when people rush to buy, and it should fall when people rush to sell. In many cases that is the "right thing," in the sense that the rush to buy/sell is in response to a real change in a company's circumstances (e.g. an outstanding earnings report, a natural disaster that harms the business, etc.). Limiting the execution of a large order would not stop insider trading, because you do not need to go to equity markets to buy/sell stock -- you can enter into a private agreement with someone to transfer shares in exchange for money. Limiting large order executions would also make index funds impossible -- index funds have to trade the stocks that make up the underlying index when customers buy or sell, and a large fund may have many individual customers buying or selling on any given day. Not all problems can be solved with technology.

dheera 6y ago

I guess my main question is, why does the stock price go up if mountains of people suddenly buy a stock? It's because we base pricing based on a simple free market order book algorithm. If the markets enforced a pricing algorithm that included certain time-based functions instead of basing it purely out of the order book, and mandate that all transactions happen at the algorithm's determined price (instead of the free market price), a lot of problems including pump-and-dump schemes and insider trading could be theoretically eliminated. We could completely legalize insider trading, for example, if we technologically mandated that large orders took weeks to execute while single shares traded in milliseconds. (I'm an engineer, not a financial expert; I view this problem as very similar to e.g. API limits and firewalls that implement rules to prevent abuse.)

betterunix2 6y ago
"The price" is just a convenient way to talk about the theoretical "value" of a company. Brokers use it to determine whether or not margin maintenance requires are being met, but in reality there is no single price at any given time. There are always two prices, the highest bid and the lowest ask, and those two prices are only meaningful for the size of the bid/ask in the order book. How would an algorithm determine the price? The whole point of the equity markets is price discovery. The price should rise when people rush to buy, and it should fall when people rush to sell. In many cases that is the "right thing," in the sense that the rush to buy/sell is in response to a real change in a company's circumstances (e.g. an outstanding earnings report, a natural disaster that harms the business, etc.). Limiting the execution of a large order would not stop insider trading, because you do not need to go to equity markets to buy/sell stock -- you can enter into a private agreement with someone to transfer shares in exchange for money. Limiting large order executions would also make index funds impossible -- index funds have to trade the stocks that make up the underlying index when customers buy or sell, and a large fund may have many individual customers buying or selling on any given day. Not all problems can be solved with technology.