Market manipulation refers to when someone tampers with regular stock trading or price in order to benefit themselves. Recognize the many tactics that someone could use to try to manipulate the market.
Market Manipulation Defined
Market manipulation is a broad phrase that refers to actions that disrupt regular capital transfers, pricing, or trading of securities. Such actions constitute fraud and are prohibited when they have the potential to undermine order or the movement of money, create an unfair trading environment, or both. They also become a major worry for state securities regulators, FINRA, the industry’s self-regulatory organization, and the Securities and Exchange Commission (SEC), the federal government body in charge of preserving fair and orderly markets.
Market manipulation, in the words of the SEC, “is when someone artificially impacts the supply or demand for an asset” (for example, causing stock prices to rise or fall dramatically). Spreading incorrect or misleading information about a product or service is one kind of market manipulation.
Methods Manipulators Use to Sway Prices
1. Spoofing
The practice of making fictitious orders and then canceling them before to execution is known as “spoofing.” Pending buy and sell orders are frequently used by investors to determine if the market is bullish or bearish on a certain company in the near future. Therefore, spoofing might give investors the impression that there is a lot of interest on one side of the market or the other when there isn’t any. Thus, the fake orders influence actual buyers or sellers to act in a specific way so that the spoofer might profit from it.
2. Wash Trades
“Wash trades” are offsetting transactions that are made with the intention of deceiving the market rather than buying or selling shares. Wash transactions can take place when a player uses two distinct brokers or when a trader and a broker collude. Offsetting deals in the derivatives markets may also be a part of it. The fake deals are designed to provide the impression of activity on one side of the market when none actually exists.
3. Pump and Dumps
In a “pump and dump” plan, a person builds up a stock holding and then makes unduly positive remarks about the firm in an effort to draw buyers and drive up the price. The player then sells to profit from the higher stock price. Pump and dump tactics are frequently used on tiny or microcap stocks because they have a higher probability of having an influence on the stock price and of luring ordinary investors who are more receptive to the message.
4. Painting the Tape
The phrase “painting the tape” alludes to the time when stock deals were printed on the ticker tape. It is an action designed to give a misleading indication that there is significant activity on one side of the market. In actuality, the player is working with a partner who is making counterproductive deals somewhere else. When it happens at the conclusion of a trading day, it is often referred to as “marking the close.”
5. Bear Raids
In a “bear raid,” a player takes a short position in a company and then makes unfavorable or concerning statements about the stock (known as “stock bashing”) in an effort to cause investors to sell their shares out of fear, which lowers the stock’s price. The player then hopes to close their short bets for a profit at significantly reduced prices.
How Do Short Sellers Impact Stock Price?
Short-selling is a common strategy used by traders, hedge funds, and investors to make money when stock prices fall. The legality of short-selling has been questioned in the past, with some accusing the practice of exacerbating market declines. However, regulatory agencies and industry experts have determined that this is not the case and view short-selling as a legitimate practice that has a positive overall impact on market efficiency and liquidity.
While shorting stocks is permitted, influencing the price of a stock to the downside in order to profit from shorting it (a bear raid) is not. (Pump and dumps to artificially inflate the price of a stock to gain from long holdings are also prohibited.)
Short-sellers are required under the uptick rule to sell on an increase in price (a
Studying Bear Raids
In 2008, two Wharton School professors researched bear raids and came to the conclusion that they had traits not present in instances where investors cooperate to push prices upward. They came to the conclusion that bear raids have the potential to hurt the firm by impacting its business prospects, capacity for acquiring funds, etc. in addition to investors. Thus, bear attacks may cause greater damage than bull raids or pump and dump operations. As a result, the regulatory organizations are aware of the risks associated with bear raids and closely monitor short sellers for any signs of dishonest behavior.
Tip: Seeking Alpha users may examine equities for favorable ratings and their degree of short interest (the proportion of outstanding short bets in a company that is short).
Bottom Line
Market manipulation done with intent is prohibited. But it does exist on the marketplace and comes in a variety of shapes. Manipulative techniques often aim to profit from the impetuousness of individual investors and are short-term in nature. Understanding the different forms of manipulation and being aware of their signs is the strongest protection an investor can have against being adversely impacted by it. Investors who maintain their composure and have a long-term perspective on investing shouldn’t have to worry about such things.
