Learn How to Spot Market Manipulation and Protect Your Investments

In January 2021, the world watched as GameStop shares went wild. This event thrust the issue of market manipulation into the spotlight. What is market manipulation, you might ask? The Securities and Exchange Commission (SEC) describes it as intentional actions aimed at deceiving or defrauding investors.¹ These actions control or artificially change security prices. In simpler terms, someone might try to cheat the market by fixing a security’s supply or demand. This makes others think the price is moving in a certain direction, when in fact, it’s not.¹ Individuals or groups, acting dishonestly, could inflate or deflate security prices to make money.¹ Their aim is to mislead others about a stock’s performance and take advantage of their mistaken beliefs. It’s worth highlighting that, up until now, no official charges have been made against WallStreetBets or others in relation to the GameStop situation.¹

Key Takeaways

Market manipulation is the intentional interference with the free forces of supply and demand to artificially affect security prices.
Techniques like pump-and-dump, wash trading, and painting the tape are used to manipulate the market.
Sudden price changes, unusual trading volumes, and erratic bid-ask spreads can be red flags of market manipulation.
Investors should exercise caution with low-volume, microcap, or penny stocks and verify information sources before trading.
Long-term investment strategies can help mitigate the risks associated with short-term market manipulation.

Understanding Market Manipulation

Definition and Key Concepts

The Securities and Exchange Commission (SEC) says market manipulation is when someone intentionally misleads or cheats investors. They do this by controlling a security’s price or messing with how supply and demand work.²³ This makes other traders and investors see the price going a different way than it really is. Mart misleaders do this to make a profit by either raising or lowering a security’s price falsely.²³

Intentional Interference with Market Forces

Market manipulators mess with the normal deal between supply and demand.²³ They want to show a fake price trend that doesn’t show the security’s real value. This tricks investors into making choices that help the manipulator, not the market as a whole.

SEC’s Definition and Regulatory Oversight

The SEC works to stop market manipulation by making and enforcing rules against it.² They point out how deceitful and wrong these tricks are, which can mess up the fairness of money markets.²³ Having groups like the SEC is key to running stock markets in a way that is clear and runs smoothly.

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Types of Market Manipulation

The Securities and Exchange Commission (SEC) breaks down market manipulation into two categories. These are pump and dump schemes, and trading manipulations.²

Pump and Dump Schemes

A pump and dump scheme involves spreading false info about a stock to boost its demand and price.² Those using this scheme lie, saying a stock will do really well. Or they might start rumors of future big deals. This gets potential investors to pay attention. Once the scam works, the ‘dumping’ phase happens. Those behind the scheme sell their shares at the now-higher price.²

Trading Manipulation Techniques

Market manipulation can also happen through trading. For example, there’s wash trading and painting the tape.² In wash trading, people trade the same security back and forth quickly. This move is to make it look like the stock is really popular.² Painting the tape involves a few people trading a stock among themselves to push up its price.²

Wash Trading and Painting the Tape

Wash trading and painting the tape trick others into thinking a stock is in high demand.² These acts aim to fool investors on a stock’s real value and popularity. This way, the tricksters make money off naive market players.²

Market Manipulation Red Flags

There are signs to look for in spotting market manipulation. These include sudden changes in stock prices without big news. Also, look for unusual trading volumes and odd bid-ask spreads.⁴ Finding a big increase in a stock’s trading should make you cautious. Do more research before you buy or sell.⁵ Price changes with no clear cause might be tricks to confuse or cheat investors.⁵ Seeing big orders that don’t fit with the market could mean someone is spoofing to manipulate it.⁵

Sudden Price Changes without Justification

When stock prices change suddenly for no clear reason, it could be a sign of manipulation.⁵ These changes may not really reflect the market’s true supply and demand. Instead, they might be a result of artificial influence.⁵

Unusual Trading Volumes

If the amount of trading is very high or very low, and there’s no news, it could mean someone is manipulating the market.⁵ A sudden surge in trading, especially in little-known stocks, could point to schemes where prices are pumped up only to be sold at a higher price later.⁵

Erratic Bid-Ask Spreads

Noticeable and hard to explain changes in the bid-ask spread are also something to watch for. This spread is the difference between the highest buying price and the lowest selling price.⁵ Manipulators might be using tactics like spoofing and layering to make the market look busier than it is. This can lead to false price impressions and strange bid-ask spreads.⁵

Being aware of these potential signs of market manipulation is crucial for investors. By watching out for them and being cautious, investors can protect themselves from being tricked or losing money.⁴

Decoding Manipulation Schemes

In the world of financial markets, manipulation schemes can harm investors. It’s key to know these deceptive practices to keep your investments safe.⁶

Anatomy of a Pump-and-Dump Scheme

The pump-and-dump scheme is a well-known form of market manipulation. It begins with the manipulators buying lots of a cheap stock.⁶ Then, they hype up the stock with false news or rumors to get short-term traders interested.⁶ When the price goes up, they sell, causing the stock to drop and investors to lose money.⁶

Bear Raids and Short Selling Strategies

Bear raids are another way to manipulate the market. Short sellers aim to lower a stock’s price.⁶ They might spread bad news, leading to investors selling the stock and its price falling.⁶ This lets bear raiders profit from the stock’s reduced value and hurt long-term investors.⁶

The Churning Phenomenon

Churning, a market manipulation type, misuses client accounts with too many trades. This is done by brokers to earn more commission, not for the client’s benefit.⁶ Such actions increase costs for the investor and can cause artificial price changes and losses.⁶

To protect their portfolios, investors must know about these schemes.⁶ Being watchful and smart in understanding market trends is crucial.⁶

Insider Trading and Market Abuse

Insider trading means using secret information to make money unfairly. It is against the law because it cheats others.⁷ The Securities and Exchange Commission (SEC) catches and punishes people doing this to keep the market fair.⁷ Spreading false news to change prices is also market abuse. The ones caught face big fines or even go to jail.⁸

New tech like artificial intelligence (AI) and machine learning now watch the market closely. They look for any signs of unfair trading, such as insider trading.⁷ The SEC and Commodity Futures Trading Commission (CFTC) use these technologies more. This helps them find wrongdoings like insider trading and market fixing.⁷ The CFTC also looks at trading data for signs of illegal practices. This includes things like creating false orders to trick the market, known as spoofing.⁷

Despite some recent lighter rulings, dealing with insider trading in large trades is still very important to the CFTC.⁷ The government is watching closely, trying to stop illegal market tricks. It is especially interested when trading moves stock prices in unexpected ways.⁷ The use of social media to fraudulently affect the market is a big concern for the SEC.⁷ Investigating fake digital asset manipulation, like pump-and-dump scams, is another top task for the CFTC.⁷

Falsely changing prices in the market or trading on secret information is illegal.⁸ Those who do this often include company leaders, traders, or so-called ‘gurus’ who trick the market with lies.⁸ Insider trading involves secret information and is on the rise, says BaFin. This is because some people try to profit from secrets about companies.⁸ There’s also a rise in stealing secrets from companies—this is to cheat in the trading world.⁸

BDO helps keep the market fair by fighting against these illegal activities.⁸ They use many ways to make sure rules are followed, like staff training and watching data.⁸ Experts at BDO look at trading details to see if there’s any cheating. They help courts understand how the cheating happened.⁸ They also write up reports that can be used in court.⁸

Strategies for Protecting Your Investments

In today’s financial world, staying alert is key to guarding your investments against market tricks. Be careful when dealing with day trading, low-volume stocks, microcaps, and penny stocks. They are often targeted by manipulators. It’s wise to be cautious with these compared to larger, more widely traded stocks.⁹

Exercising Caution with Low-Volume Stocks

Thinly-traded, or “penny,” stocks attract a lot of market manipulation. Setting firm rules, like not trading in these, can stop frauds like pump-and-dump.⁹ Always do your homework before investing in these small stocks. This can keep you safe from schemes.

Developing a Strict Asset Allocation Plan

A solid financial plan with a clear strategy for where your money goes can lower the risk of abuse. By spreading your money out in different types of investments and sectors, you’re less likely to be harmed by manipulation. Stick with your plan, especially when markets get shaky. This strategy can help keep your investments safe.

Working with a Financial Advisor

Teaming up with a trusted financial advisor is a smart move to avoid market traps. They will teach you about harmful schemes and show you how to spot warning signs. With their help, you can make a detailed financial plan that suits your goals and how much risk you’re willing to take.⁹

Being careful with less-traded stocks, following a strict plan, and having a good financial advisor are proactive ways to shield your investments. Always be alert, informed, and stick to sound investment principles. This approach is crucial for the steady growth of your investments.

Conclusion

Market manipulation is a major concern, leading to huge losses for investors.¹⁰ Knowing the signs and how to protect yourself is vital. This includes working with agencies like the U.S. SEC.¹¹ They’ve taken many actions against illegal trading and manipulation.¹¹

The issue here is defining what counts as manipulation. There’s a big debate on whether some trades are illegal.¹¹ Plus, as markets change and grow, so do the chances for manipulation.¹² This makes it harder to catch and prevent these acts.¹² Regulators need to team up across borders, but this comes with its own set of challenges.¹²

Keeping our financial markets honest is a team effort. Everyone, from officials to investors, must do their part. Staying alert and working with trustworthy advisors helps.¹⁰ This commitment is key to protecting both your investments and the market’s health.¹²