What Is a Bear Raid?
A bear raid is an illegal practice of ganging up to push a stock's price lower through concerted short selling and spreading adverse rumors about the targeted company. A bear raid is sometimes resorted to by unscrupulous short sellers who want to make a quick buck from their short positions.
A bear-raid target is generally a company that is going through a challenging period, since its vulnerable position makes it easy fodder for short sellers. While short selling is legal, coordinated short selling is viewed as market manipulation by the Securities and Exchange Commission (SEC), and spreading false rumors is tantamount to fraudulent activity.
- Bear raids are illegal if the short sellers are colluding and spreading false rumors.
- The intent of a bear raid is to force the price down quickly so as to profit from a short position, selling first and buying back at a lower price.
- Bear raids are often used as the scapegoat for stock prices which are falling for legitimate reasons. Short selling is not illegal but may push the price down if short sellers are correct in their concerns about the company or the stock's inflated price.
Understanding a Bear Raid
The objective of a bear raid is usually to make windfall profits in a brief time period through short sales. If the bear raid works and the target stock plunges, short sellers can buy the shares back cheaply on the open market. The short sellers make money by selling the shares first, at what they believe is a high price, and then buying them back to close out their position at a lower price. The short sellers profit on the difference, such as selling when the price is at $100 and buying back at $75, making a quick 25% profit.
In a typical bear raid, short sellers may collude beforehand to establish massive short positions in the target stock. Since the huge short interest in the stock increases the risk of a short squeeze that can inflict substantial losses on the shorts, the short sellers cannot afford to wait patiently for months until their short strategy works out.
So they embark on the next step in the bear raid which is akin to a smear campaign, with whispers and rumors about the company spread by unknown sources. These rumors can be anything that portrays the target company in a negative light, such as allegations of accounting fraud, an SEC investigation, an earnings miss, financial difficulties, and so on. The rumors may cause nervous investors to exit the stock in droves, driving the price down further and giving the short sellers the profit they are looking for.
The repeal of the uptick rule in July 2007 is regarded by some experts as having made it easier for short sellers to embark on bear raids. The collapse or near-collapse of a number of leading financial institutions in 2008 is attributed in some circles to bear raids.
While bear raids may involve collusion and false rumors, which is illegal, there are also legal bear raids which is when a large number of people (or a few people) start shorting a large amount stock due to their concern with a company. They may also voice their legitimate concerns. As long as the information is not intentionally false and the shorts are not colluding with each other, a stock may see downward pressure due to the selling and increasing negative news. Many people will refer to this natural market behavior as a bear raid.
Bear Raids as an Excuse for Falling Stocks
When a stock price falls, especially when the company is embroiled in some controversy, owners of the stock often attribute the falling price to bears or short sellers. Short sellers have been at least partially blamed for most major stock market crashes in history. Typically short sellers are not the cause of falling prices, people who are selling current holdings are. Short interest can be tracked via the short interest figures.
Yet, short sellers actually play a pivotal role in the markets. It is often the short sellers who reveal or bring to light major problems within companies. In many cases, these are not fabricated stories meant to temporarily push the price down, but actual facts which could greatly affect the value of the company. While most people are pushing good news to drive prices up, the bears present the opposite side of the argument, helping stocks stay closer to their true value.
Therefore, it is important to differentiate between unsubstantiated rumors and facts. While many falling stocks will be blamed on bear raiders, the key for investors is discerning whether the company is in real trouble or if the sell-off is a temporary hiccup or due to other factors such as a market-wide or sector-wide selloff.
Not all falling stocks are caused by bear raids. And sometimes a bear raid may have a legitimate cause, as the company may actually be in serious trouble or the stock price is too inflated yet it hasn't become obvious to the masses yet. The key difference between an illegal bear raid and short sellers expressing their concern about a company is whether the short sellers have colluded and are spreading false information. Sometimes this isn't known for some time after the raid begins.
Example of a Legal Bear Raid in the Pound Sterling
One of the most well-known trades in history is commonly referred to as a bear raid, or currency raid, yet it was legal because it didn't involve collusion and was based on sound reasoning and not false rumors.
In 1992 George Soros began selling the British pound. In currencies, while the word "shorting" is used, one currency is just exchanged for another currency. So by selling pounds, Soros was buying other currencies against the pound.
Soros was selling pounds because he believed that Britain would be unable to hold their currency within the band stipulated by the European Exchange Rate Mechanism (ERM). This mechanism was designed to stabilize exchange rates in Europe and required that the pound stay within 6% of other ERM currencies. The problem was that Britain had an inflation rate far higher than some other countries in the ERM, like Germany.
The ERM forced Britain to hold their currency up, within the band, at artificially high levels. Soros saw this and believed that ultimately Britain would be unable to hold the currency in the band for long and would eventually have to abandon the ERM. With the currency no longer artificially inflated by Britain buying pounds in an effort to hold the currency in the band, the pound would fall.
On September 16, 1992, Britain did abandon the ERM after several last-ditch attempts to support the currency—like raising interest rates from 10% to 12%, and then saying they would raise the rates to 15%, although that last raise didn't come to fruition.