A couple of years ago Dark pool trading was a term that even veteran investors never heard of, but after recent scandals, it’s of vital importance to fully grasp what it is, and how hedge funds can use it to take advantage of not just AMC investors but all stock traders in general. With this in mind, no AMC stock discussion is complete without analyzing what dark pools are and how they affect short squeezes.

Dark Pools

A dark pool is a privately organized financial forum or exchange for trading securities. It serves as a type of alternative trading system (ATS) that allows investors to trade without exposure. When an investor decides to buy a stock, their broker, such as RobinHood, will then send the buy order to dark pools such as Bloomberg Tradebok or Citadel. The dark pool then matches one’s buying order with another selling order. The way dark pools carry out this operation is by setting the price for the transaction, unlike open markets such as the NYSE.

In general, the price may not differ at all, however, according to Matt Lauer, there are cases reported with differences as much as 25%. This dangerous volatility can be traced back to these marketplaces’ lack of transparency. By timing the selling and buying orders to match their own interests, dark pools can ‘flatten’ out price spikes as well as induce arbitrary price spikes and dips. However, these artificial dips and spikes are only momentary because the demand will have to meet supply at an equilibrium point

These temporary spikes and dips generate fear or trigger stop-loss orders which Citadel can orchestrate to their advantage. They see retail orders submitted in real-time and can adjust their own positions accordingly, giving them an information advantage over the public who does not have access to the same information. For example, if demand unexpectedly increases, they may pause their short ladder attack to let it decrease again before resuming their attack. For this reason, many investors are looking for brokers that allow investors to choose the marketplace they prefer to trade in to avoid this disadvantage. Brokers like Fidelity ensure that orders go to the top-performing market center for the best execution price. It also allows investors to determine where trades are routed using the Directed Trade feature available on the free Active Trader Pro (ATP) platform. Also, using Ameritrade can help investors avoid dark pools by enabling direct routing of investors’ accounts.

Hedge Fund Exploitation

Hedge fund exploitation AMC stock discussion

When talking about dark pools, it’s important to understand that hedge funds are able to exploit stop-loss orders as a result. They carry out short ladder attacks, by heavily shorting a stock. This causes the stock’s value to dip, subsequently triggering stop losses and a chain reaction forcing the stock’s value to spiral.

Hedge Funds follow a particular pattern to ignite this process. They begin by borrowing the maximum number of shares they can – usually a few million – before quickly starting to sell them off to force the price down. Eventually, the price will drop enough to trigger a stop-loss order chain reaction. After hitting their target hedge funds will begin buying the shares, however, if enough stop-loss orders were triggered, the stock would not return to its original price.

Because this is a predictable pattern, investors are able to use this attack against hedge funds. Using Fintel or Ortex investors can see how many shares were borrowed and spot this pattern in its early stages. Once the limit for borrowed shares is met and the price can no longer be pushed lower – investors are able to buy shares at this dip price.

Buying the dip and holding are effective strategies for making hedge funds’ short ladder attacks costly while limiting the number of shares available to be borrowed. This, in turn, increases AMC investors’ share of the float. But it’s important that investors do their own DD and avoid outlets that could be spreading misinformation.

Hedge funds employ other tactics as well like pushing different “meme stocks” to divide retail investors. For this reason, it’s safer to target one stock as a community rather than risk being divided among multiple. The first step to identifying a short squeeze candidate is finding out how many shares are shorted and who owns how many shares. It’s also important to see if there is an institutional investor who would sell before the squeeze materializes.

AMC Stock Discussion

Short squeeze AMC stock discussion

With that in mind, this AMC stock discussion will provide the perfect example. Shorted AMC shares already exceed more than 18.69%. According to AMC’s June shareholder count, retailers own more than 80% of AMC shares. But the company’s largest institutional owners are either index funds like Vanguard or institutions such as BlackRock which don’t have the capacity to affect a short squeeze. Because index funds are required to hold a certain amount of the underlying stocks in their funds, they cannot sell shares whenever they wish to.

This means AMC retail investors are primarily concerned with those shares managed by hedge funds and not index funds. However, index funds might accelerate the squeeze because they need to hold and even buy a certain amount of stocks in their index under certain circumstances. For example, if the price of one company in their index goes up disproportionately then an index may be triggered into buying more shares.

As it stands Vanguard has 43.7 million shares in several index funds which put these shares temporarily out of action so to speak. BlackRock Fund Advisors hold 26.7 million shares in index funds and may own additional shares outside the index funds. Invesco’s shares are also put entirely in index funds which leave around 7.94% of all AMC shares – roughly 39 million shares – that could be in institutional hands and sold during a short squeeze.

If AMC investors own more than 80% of all shares, and around 12% of all shares are invested in index funds, then hedge funds are unable to cover their shorts which are 20% of all shares. Assuming all 7.94% could be sold during a squeeze, the ratio of available shares to shorts is about 2.5.

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