A short ladder attack is a supposed trading condition in which hedge fund sellers come together to drive down a stock price that is already undergoing bearish pressure. Retail investors are often seen as the victims in this situation.
While not a purely defined strategy, some individual investors believe that these efforts work to the detriment of smaller traders. The theory is that as an asset’s price moves lower it prompts other investors to dump shares, leading to prices spiraling even lower.
How Does a Short Ladder Attack Work?
The short ladder attack strategy became notorious during the meme stock craze of early 2021 when shares of companies like GameStop (GME) and AMC Entertainment (AMC) experienced intense volatility and massive short squeezes. It was alleged that large investors responded with short ladder attacks to drive prices back down.
In 2022, there was even some chatter that various cryptocurrencies were targeted for the same bearish strategy.
A short ladder attack begins when an institution builds a large short position in a security. Being short involves buying shares, then immediately lending them out with the goal of re-acquiring them at a lower price. As the asset drops in value, the short seller profits.
The maximum profit on a short play is when the asset drops to $0, perhaps when bankruptcy is made official by the targeted company. A short ladder attack is meant to give the impression that shares of a stock (or any asset) are not worth what bullish investors believe, thus inducing other traders to dump shares or simply discourage others from buying.
Are Short Ladder Attacks Legal?
Short ladder attacks are usually legal trading tactics, but when market manipulation laws are breached, it becomes a serious crime. It is important to recognize that short selling volatile assets is an age-old Wall Street practice.
In general, there is nothing nefarious about shorting a stock. In fact, according to the U.S. Securities and Exchange Commission (SEC), short sellers add liquidity to the market. More liquidity can reduce trading costs for other market participants.
During bear markets, however, short sellers often come under scrutiny from both regulators and the investing public for their perceived efforts to bring down key stocks and the broader market.
In extraordinary situations, shorting stocks is sometimes ruled illegal — at least temporarily. Regulators will occasionally ban selling groups of assets short with the goal of stabilizing financial markets during periods of turmoil, such as during the Great Depression and the financial crisis of 2008-09. Beyond those instances, short selling is not illegal.
Short ladder attacks are infamous in the sense that traders engaging in such a strategy seek to drive asset prices lower. The tactic is not illegal, however. At times, though, there can be illegal attempts to take a stock price down.
Where is the line drawn? It’s when a trader manipulates the laws using malicious activities like lying about a company, bribing others to not buy shares of the targeted firm, or the practice of spoofing.
Example of a Short Ladder Attack
Short ladder attacks are not something traders see every day. In fact, they can be hard to spot. It’s not a truly defined term, rather it is a loose theory.
Still, market analysts and traders can suspect a certain stock is under this “attack.” Potential examples include popular Wallstreetbets meme stocks from early- to mid-2021: GameStop (GME), AMC Entertainment (AMC), and Bed Bath & Beyond (BBBY).
When shares of those companies began to falter during the first quarter of 2021, after their meteoric rise in the preceding weeks, conspiracies began to arise within internet chat rooms. Retail investors, who had lost money by being long those shares, claimed they were victims of unscrupulous trading strategies employed by large funds by way of short ladder attacks. It was thought that hedge funds came together to enter low bids that drove those securities lower.
Ask a short seller, and they might tell you that this strategy does not exist. After all, conspiracies to drive down a share price could venture into the market manipulation area, which would be against financial market rules.
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How Can You Identify a Short Ladder Attack?
Even as big-time traders dismiss the practice, short ladder attacks are thought by some retail traders to be a normal practice. Spotting these maneuvers is no easy task since selling pressure can come from a host of market participants for a variety of reasons.
Perhaps there is bad news about a company that might fundamentally bring about the bears (who have no ill intent). Maybe a stock drops below a key technical level, leading to further selling. Moreover, it could be that major company insiders are dumping shares simply to raise cash for personal reasons. All these scenarios can give the impression of a short ladder attack.
You still might wonder, “what is a short ladder attack?” in real life. Some possible hallmarks could be high volume on downward price moves. Also, be on the lookout for brief squeezes in which short sellers are forced to engage in covering — when bears quickly buy back stock they are short to avoid steep losses. Also, stocks with high short interest could be targets of a short ladder attack. Basically, whenever floods of offers hit a stock for no apparent reason, that could be a short ladder attack signature.
You might recall the mother of all short squeezes (colloquially named MOASS) term. It’s when a flood of buyers bid up shares that were being shorted by other investors. GameStop’s example was one to behold in that the price jumped hundreds of percent over the course of a few days.
Short Ladder Attacks and Wallstreetbets
According to those on Wallstreetbets, short ladder attacks exist to work against individual investors. By flooding the market with offers, the supply/demand balance tips greatly in favor of the bears. Posts on Wallstreetbets attempted to call out the practice, but little (if any) regulatory action has been taken.
This abusive ploy is alleged to be executed by a consortium of hedge funds, prime brokers, and even potentially regulators and clearinghouses. Target stocks are determined and prioritized, almost like a hit list. After driving shares lower, the short sellers avoid capital gains tax since they never have to cover their shares.
The Takeaway
Short ladder attacks are alleged bearish trading activities performed by large institutional traders that work against retail traders who are long a stock.
While the practice is not illegal on its own, crossing the line into market manipulation will catch the eye of regulators. Many large hedge fund managers claim to be unaware of such a practice. Additionally, research firm Muddy Waters is highly skeptical that short ladder attacks truly exist. Still, retail traders on internet stock trading forums claim they were victimized by short ladder attacks.
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