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Market manipulation

Market manipulation within the financial markets​ is the attempt to influence the behaviour of others into a certain action, which may result in the loss of their capital. It is an attempt to artificially affect the price and supply and demand for a financial instrument, such as a share, currency pair or commodity. Market manipulation takes on many forms and it is important for traders to be aware of how it affects them, others, and their open positions. With this knowledge, the trader may be better able to avoid deceptive and potentially risky situations involving manipulation.

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What is market manipulation?

Market manipulation is the attempt to artificially increase or decrease the price of a security. It is artificial because the manipulator is attempting to skew supply and demand to push the price in a favourable direction for them.

While supply and demand for an asset can change at any time based on other fundamental analysis factors​, including news announcements, earnings reports and investors’ decision processes, manipulation typically involves illegal means, such as spreading false information, trying to influence price quotes or posting fake orders.

While market manipulation is usually thought of in terms of assets such as stocks, currencies, or commodities, manipulation can also affect other things such as overnight interest rates, resulting in millions of dollars being made or lost. Such manipulation may require the central banks or other regulatory bodies to intervene.

Is market manipulation illegal?

There are many forms of market manipulation, and these known forms are illegal. Unfortunately, new forms of manipulation do sometimes occur, especially as new technologies and markets emerge. An example of this is the attempt to spread false information or post fake orders, artificially inflating or deflating digital currency prices, which most countries have not yet developed laws around.

Many traders equate their own losses to market manipulation. While this may sometimes be the case, often it is not. Markets move up and down, and the trader may just be competing against much better traders. Here’s an example that is not illegal, but that some traders may complain about.

Trader A buys shares in Company XYZ, and immediately after, a Big Trader starts selling their shares for a profit. Trader A sells their stock at a loss. The Big Trader watches the price decline and decides that it is time to start buying again. They sweep up all the shares, pushing the price back up. Other traders jump on board, pushing it up even more. Trader A thinks that the stock is going to keep rising this time, so they buy again. Shortly after, the Big Trader, having made a sufficient profit, begins to sell their shares again. The price falls and Trader A sells at a loss again. Trader A may claim that the market is manipulated.

While someone did get better entries and exits than Trader A, there is no illegal process involved, as the pair are shorting stocks​ within the share market. The Big Trader wanted to buy and sell legitimately, and so did Trader A, whereas illegal manipulation typically equates to false information or something artificial being made to appear real.

Market manipulation strategies

Bear raid

A bear raid is when short sellers try to push down the price of a security, often by spreading false information. The bear raider profits by short selling early and then spreading false information. As other people sell or short, the price drops and the bear raider experiences a profit.

Short selling isn’t necessarily illegal. When a stock drops because of lots of short selling, the term “bear raid” is often inaccurately used. If the selling and shorting are for legitimate reasons, such as the company is in trouble or investors view the stock as too risky, then it is simply bearish price action in the stock, not a bear raid.

When many people get short in a stock, such as in a bear raid, there is a possibility of a short squeeze​. If the price of the asset rises, these short sellers must then buy the stock back in order to close their short positions, helping to fuel the rally. A bear raid that fails could result in a short squeeze.

Bear raids can take place over weeks and months, and they can therefore have a substantial impact on longer-term investors who are hoping that the stock will bounce back from the intense selling pressure.

Wash trading

Wash trading is a way to make a stock look more active than it is to lure in other traders who notice the increased trade activity. Wash trading is essentially buying and selling orders that counteract each with no material gain or loss being made. These orders are created hundreds or thousands of times a day to increase the volume of the stock and attract other traders.

For example, two accounts could be opened by the same person and the person buys and sells back and forth between the two accounts. Although this increases volume on the stock, the trader isn’t actually making a profit, or even attempting to, on these wash trades.

The purpose of wash trading may be to attract others into the market, to affect the price of the security, or to distort volume figures. Wash trading primarily affects short-term traders, such as day traders and scalpers, who may get caught up in the rapid buying and selling process. Since it tends not to last long, it may have a lesser effect on longer-term investors.

Fake news

Spreading fake news about a company to influence others into performing a certain action is illegal. It is a market manipulation tactic that is fairly widespread among retail investors in chat rooms and message boards. While fake news may seem relatively harmless, it can carry heavy fines and even jail time.

A short squeeze is not illegal but spreading false information in an attempt to create the short squeeze is illegal. Fake news potentially hurts both long and short-term traders, since the impact on price can be significant, even if it is sometimes temporary. This can also affect company fundamentals​.

Spoofing

Spoofing is posting typically large orders with no intention of being filled on those orders. The purpose is to make it look like there are lots of buyers or sellers within the market, when in fact there are not. The false information may influence others to buy or sell, which the spoofer can potentially profit from.

Spoofing is seen on the bid and ask volume of a security. Therefore, it primarily only affects short-term traders.

Pump and dump

Many people have received spam emails claiming the amazing prospect of a currently unknown company, typically a penny stock. The people sending these emails have likely already loaded up on the stock and are now trying to entice others to buy it, thus increasing the price.

The people perpetrating the pump and dump may have no actual desire to hold on to the stock long-term. They simply are trying to entice others into the stock so that it can be sold for a profit at a higher price. Very few of the retail investors who buy the stock will realise a profit, and most will lose some of their capital. As soon as the buying fizzles out and original buyers decide to sell, the stock goes back to the price it was at before, or possibly even lower.

People looking for a quick profit, typically short-term traders, are most likely to get lured into a pump and dump, but longer-term investors may be lured in as well by all the glorious prospects for the company that they are promised.

Worried about the effects of market manipulation on the financial markets? Open a demo account to practise trading with virtual funds first.

Churning

Churning is when a fund manager, broker or wealth manager increases trade activity on behalf of the client simply to generate commissions for themselves. This method of market manipulation is illegal and a violation of the fiduciary duty of the fund manager/broker. When commission costs increase due to high trading activity, yet returns remain stagnant or even drop, this could indicate churning.

Since it is long-term investors who typically have funds under management, this issue mostly affects longer-term traders. Read more about trading costs that can be affected by market manipulation tactics.

Front running/insider information

Acting on inside information means taking financial action as a result of knowing something that is not public information. For example, Sally works for a company and overhears that the company is releasing major news, which is likely to be very profitable for the company. If that news hasn’t been released to the public, it is an illegal act for Sally to buy the company’s stock hoping to profit from the news. Once the news is public, then Sally can buy the stock if she wishes.

Acting on insider information is also called front running because an asset is being bought or sold ahead of a public announcement that could materially affect the value of the security. A government employee buying or selling in a related market before releasing an economic report is also front running. They get to know the information before the public does (making them an insider), but they can’t legally act on that information until it is public. Such laws keep the marketplace fair for all participants, and don’t favour people with early access to information. Learn more about event-driven trading strategies​.

Cornering the market

Cornering the market refers to when an entity tries to gain majority control of a commodity, stock or other asset in order to manipulate the price of that asset. By controlling so much, they can dictate what others must pay for it. Historically, those who have tried to corner a financial market have failed. Furthermore, it is illegal, so success is not likely an option. Meme stocks​ are often a result of this tactic.

When a company has a monopoly position in an industry, that is also called cornering, since the company has complete control of that industry. If a market were to be cornered, it takes time, so it would mostly affect longer-term investors.

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Market manipulation examples

Example of spoofing or posting fake orders:

In 2020, British day trader Narinder Sarao, who traded from his parent’s house, was sentenced to one-year house arrest for posting massive fake orders. The spoofing contributed to the 2010 “flash crash” where the Dow Jones Industrial Average index plunged about 600 points in several minutes.

Example of fake news:

In another interesting case, in 2000, the Securities and Exchange (SEC) brought a case against a 14-year old for posting hundreds of online messages with false claims about micro-cap (small market capitalisation) stocks, also called penny stocks. The minor had made more than $800,000 in profits from the scheme.

Example of front running/insider information:

Another example of market manipulation relates to Martha Stewart. She became caught up in insider trading in 2001 when the CEO of a company she was invested in advised family and friends to sell their shares in experimental drug Erbitux. Days later, the US Food and Drug Administration announced it would not approve the pharmaceutical drug. The stock price plunged. For acting on the non-public tip, Martha Steward was ordered to spend five months in jail and paid a fine of almost $200,000 for her role in the manipulation.

How to prevent market manipulation

Knowing how certain markets are manipulated in the trading world can help you to avoid getting caught up in it. If you are worried about investing a large amount of capital into long-term positions that may encounter some form of market manipulation, you can always choose to trade in the short-term with spread bets and CFDs. These types of derivative products allow you to buy and sell assets in a range of timeframes, both short and long-term. However, trading with leverage also comes with a number of risks that you should be aware of before opening any positions. Read more about leveraged trading.

You can also look out for tell-tale signs that market manipulation is happening in your chosen market. For example:

  • Bear raids are characterised by strong selling. Utilising stop-losses on long positions can help to limit losses if a bear raid occurs. However, these are not 100% effective and do not take into account gapping or slippage in the financial markets.
  • Wash trading is characterised by large volume increases with little price action.
  • To avoid fake news, check multiple sources before relying on information to make trading decisions. The dedicated news and analysis section on our platform is updated daily with reputable and reliable commentary from our market analysts, and we also have reports from Reuters and Morningstar available.
  • When day trading, spotting excessively large bids and offers that may disappear and reappear frequently is usually spoofing. This is an attempt to manipulate your actions.
  • You could avoid pump and dumps by creating your own strategy and not getting lured in by claims that seem too good to be true. Having an exit plan for any trade you get into can also help to protect profits and limit losses.
  • If your wealth manager is ramping up commissions while returns stay stagnant or sink, you may be a victim of churning. Some traders may decide to lodge a complaint.
  • Insider information is not something that can be legally acted on. Therefore, traders should understand the consequences of acting on information that is not public but that could have a material impact on the price of a security.

As a guideline, manipulation may appear easier in penny stocks and stocks with little volume, since it takes less money to manipulate the price of the security. That said, market manipulation can occur anytime, anywhere.

Consequences of market manipulation

Manipulation of any security type creates an unfair playing field and can destabilise financial markets if it runs rampant. Perhaps fewer people would invest if they knew they were likely to be taken advantage of.

The goal of market manipulation is typically profit, yet not always. No matter the motive, retail traders tend to get hurt when they get involved in a security that is being manipulated, typically by a more experienced trader. The manipulator’s profits come from retail traders who do not realise the potential threats, and who were maybe looking to make a quick profit for themselves.

When trading, it is always a good idea to think of risk controls. Some traders choose to control position size so that only a small amount of capital is at risk on any single trade, and all traders should be wary of the signs of market manipulation, so that they avoid opening positions within volatile markets and prevent unnecessary losses.

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Disclaimer: CMC Markets is an execution-only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although we are not specifically prevented from dealing before providing this material, we do not seek to take advantage of the material prior to its dissemination.