Market Manipulation

It is a practice of deceiving investors by affecting the supply and demand for a stock, finally influencing its price in the market

Matthew Retzloff

Reviewed by

Matthew Retzloff

Expertise: Investment Banking | Corporate Development


August 26, 2022

Market manipulation is a practice of deceiving investors by affecting the supply and demand for a stock, finally influencing its price in the market. The manipulators who orchestrate the price for such securities then profit at the expense of other investors.

In the US, Section 9 of the Securities Exchange Act of 1934 prohibits market manipulation. In addition, whistling electricity markets under Section 222 of the Federal Power Act and wholesale natural gas markets under Section 4A of the Natural Gas Act are also prohibited.

The US Securities Exchange Act defines market manipulation as "transactions which create an artificial price or maintain an artificial price for a tradable security."

Manipulation is illegal in most countries but can be hard to track down and prove to the authorities. It may include incorrect declarations but always aims to drive the prices of the securities to benefit the manipulators.

But as the size of the capital markets gets more prominent and the number of participants in it increases, it becomes more and more difficult for regulating authorities to catch manipulators.

Why is it a problem?

Market manipulation is a problem for the authorities, companies, and investors in the markets. There are many reasons market manipulation is an issue, but there are also many ways to solve it.

First of all, it harms the integrity of the markets. As a result, investors tend to stay out of the market. Consequently, this can impact investments in the markets and the supply of factors of production, reducing output. It is harmful to the company and the economy.

Manipulation undermines fair, unbiased, and organized markets. Instead, demand and supply should determine prices in the market.

Currency Manipulation

There are many ways to calculate the exchange rate. First, the forces of demand and supply determine it. It is the comparative value of a currency indicated by another currency or a group of currencies.

Exchange rates can act as a significant economic indicator for counties that actively participate in international markets. However, it can vary due to many issues like inflation, the balance of payments, or economic activity.

Currency manipulation is a technique through which countries weaken their currency to boost economic trade and business. They manipulate the money by buying and selling it in the commodities market, increasing exports and decreasing imports.

It is reviewed as a separate class by authorities such as the government. They can be accused of manipulating a currency if they fix an exchange rate or secretly tamper with it.

Techniques of Stock Manipulation

A few of the techniques are:

1. Churning

This is a practice where the trader enters a trade to increase the commission he/she earns. Then, the trader puts the buy and sells orders at comparable prices to increase the trading activity.

As a result, we witness an increased market activity and trade volume for the security, making it a hot commodity for other investors and more interested in the stock. As a result, it can lead to an abnormal increase in its price.

This scenario usually happens with clients associated with commission-based brokers who charge a commission on every trade they execute on behalf of the client.

Unauthorized trading, frequent buying and selling, and excessive fees might be some of the warning signs that your broker might be churning to drive up commission fees.

2. Reverse churning

Doctors treat a patient and get compensated for their service; this has been the practice in the service world for decades.

However, your broker can be paid by you even though he/she hasn't done anything, which isn't against the law. This scenario is called reverse churning.

A brokerage account that is charged on a fixed-fee basis and not on a commission-per-trade basis is how this happens. For example, suppose a client directs the broker to trade very little through his/her account.

This way, the broker's commissions are cut by a considerable proportion. In such a situation, the broker starts charging a fixed commission to the client on the brokerage account.

The trades in the client's accounts are minimal; the broker virtually has no work. The deal becomes a simple arrangement of a money transfer from the client to the broker for little to no work.

3. Stock Bashing

A stock basher is a person who spreads misinformation about a stock, so the general public loses trust, leading to a fall in the price of a stock.

4. Pump and Dump 

A pump and dump is a market manipulation scheme wherein the fraudsters spread false information about a company, but, in this case, this information is in favor of the company.

Usually, these people are stockholders of the company. The false news and advertising, exaggerated statements, and recommendations lead investors to gain trust in the company and buy the security.

After a certain amount of time, when the security has achieved a profit, they stop hyping the stock and "dump" their positions for huge gains.

Magazines, social media, cold calling, and emailing can spread false rumors, news, and accusations.

5. Ramping

This technique is like a pump and dump. Shareholders spread false information, advertising the company's offerings and services.

This information is usually about the company's profitability and future earnings expectations to drive the stock's price and sell it off after making a significant profit.

6. Wash trade

Wash trading is a practice where a trader repeatedly buys and sells the same security to pump up the stock volume.

The stock looks more desirable and, therefore, artificially results in a higher security price. This manipulation can also be used to gain commissions for brokers who charge their clients on the number of trades.

7. Bear Raid

A bear raid is used to drive down the stock price of a security, mainly through short selling. First, false information and news are spread to drive down the price. After that, these fraudsters short-sell the stock and profit from such activities. This trap is done mainly to companies under financial duress or with a bad market reputation.

8. Lure and Squeeze

This technique applies to a company with bad financials (high debts), losses for the past few years, poor fundamentals, and few assets to show. These are usually the signs of imminent bankruptcy.

The stock price gradually falls as people short-sell the stock regularly. This phenomenon continues until the number of shares shorted is well over the number of shares not held by those who know about this scheme.

For the time being, the people running this scheme keep buying this stock as it falls to lower levels. When it drops to a low price point, the company announces it has struck a deal with the creditors for stock.

This way, the price of the stock shoots up. The people in the loop the whole time start selling it near the peak price until the company's stock price returns to normal and the cycle can repeat.

9. Quote Stuffing - Quote stuffing is the practice of placing huge buy- and sell-side orders for a particular stock by a high-frequency trader and quickly withdrawing them to flood the market with quotes for a stock.

This manipulation is done by using top-of-the-line hardware, software, and programs enabling high-frequency traders to get an undue advantage over other traders.

As a result, it can "stuff" the pipeline with considerable orders in a concise amount of time (say, a few seconds), which are then canceled, slowing down the systems and creating other problems in security exchanges.

10. Spoofing

Spoofing is a disruptive algorithm practice in the cryptocurrencies and commodities market. It involves placing enormous orders for futures & options and canceling them before execution.

It paints a false picture in the eyes of the public, creating a false sentiment in the market. The spoofer, in this case, can use the market fluctuations to their advantage and earn significant profits.

Spoofing is considered a market manipulation technique and is generally done by high-frequency traders (HFTs).

11. Price fixing

This is a technique of market manipulation where parties conspire to fix the prices of a particular commodity to earn profits at the expense of the consumers. This technique is also called "price rigging" or "collusion."

12. High-closing

High-closing is a technique wherein stock manipulators make small trades during the last minutes of the day's trading. This trick increases the stock's closing price and shows traders that the stock performed well.

13. Cornering the market

Cornering the market involves a trader or a group of traders buying a large chunk of the supply of a stock, commodity, or other assets to gain control, allowing them to manipulate prices as if they were a monopoly.

You can corner the market by buying a huge chunk or accumulating a massive percentage over time.

A cornerer may aim to buy a vast number of futures contracts. Then, the cornerer will inflate the price, allowing him to sell for a massive profit.

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Researched and authored by Prabhav Gupta | LinkedIn

Reviewed and edited by James Fazeli-Sinaki | LinkedIn

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