Table of Contents
The definition of market manipulation, according to the Securities and Exchange Commission (SEC), is a deliberate, illegal interference in markets to alter the price of securities and defraud investors. In short, market manipulation is just what it sounds like, and unfortunately it’s not uncommon — but it can be difficult to prove.
There are numerous schemes that people use to manipulate market outcomes, including pump-and-dump and poop-and-scoop.
Given the legal perils, and the chance that investors could get caught up in some form of market manipulation, it’s critical to have a basic understanding of what it is and what it can look like.
Key Points
• Market manipulation is the illegal attempt to alter the price of a security and/or defraud investors.
• There are numerous ways that bad actors try to influence the price of a security in order to profit.
• Pump-and-dump is one common scheme, where the price of a microcap stock is artificially inflated before it’s sold.
• While not uncommon, market manipulation can be difficult to prove.
• Investors can protect themselves by knowing the red flags of market manipulation.
What Is Market Manipulation?
According to the U.S. Securities and Exchange Commission, the definition of market manipulation is the “Intentional or willful conduct designed to deceive or defraud investors by controlling or artificially affecting the price of securities, or the Intentional interference with the free forces of supply and demand.”
For example, any action to impact the supply or demand for a stock and drive a stock’s price up or down by artificial means constitutes stock market manipulation.
The SEC views market manipulation as harmful, since the practice “affects the integrity of the marketplace.” According to the regulatory agency, financial market prices “should be set by the unimpeded collective judgment of buyers and sellers.” Anything else would undermine the orderly execution and trustworthiness of the markets.
The SEC has warned market leaders that investors will “stay out of your market if they perceive that it is not fair and is subject to market manipulation.”
Recommended: What Are Securities in Finance?
What Are Examples of Market Manipulation?
There are several methods that market manipulators use to interfere with markets, creating investment risk for those who fall victim to their schemes.
“Pump-and-Dump”
The pump-and-dump scheme is a common form of market manipulation. It occurs when a market participant who holds a specific investment knowingly issues false or misleading statements about the underlying company in order to pump up the price.
When investors fall for the information and buy the stock, the manipulator can either short the stock, or wait for the optimal price point and then sell the stock before the truth emerges, and investors dump their holdings.
For example, a market manipulator may start a rumor that a publicly traded company is going to be bought by a larger company. If enough investors believe the rumor, more investors buy the stock (whether via an online investing platform or through a brokerage), pushing up the stock price.
Once the price hits a certain level, the aim is to sell shares of the stock and pocket a potentially significant profit. Those investors who don’t sell are left with a stock that could drop in price when they realize the underlying company isn’t being bought out.
The Poop-and-Scoop Scheme
The so-called poop-and-scoop scam is the reverse of a pump-and-dump. Here, fraudulent rumors are spread with the aim of pushing down a security’s price. Again, the stock could be shorted or bought at a low point, and sold when the rumors abate and the price rebounds.
The “Wash” Method
Wash trading is a form of market manipulation where a group of investors acting in tandem buy and sell the same stock repeatedly over a period of a few days or even a few hours.
By and large, an “active” trading period of a stock is considered a sign of an increase in value, and the stock may swing upward as more investors notice the stock is being actively and even aggressively traded.
This scheme, also known as “painting the tape,” makes it seem as if investors are trading stocks actively when they’re not.
Trade “Spoofing”
The practice of trade spoofing is also known as “layering,” and occurs when market manipulators set trading orders with brokers they have no intention of executing.
In financial markets, it’s common for market orders to be public. When large orders to buy or sell a certain security are made, other investors jump aboard hoping to piggyback the unexecuted trade, thus drumming up more interest — and more investors — in the security.
Market manipulators leverage that momentum trading, and wait until the time is right to buy or sell the security as other investors’ trader orders are fulfilled.
With the “spoof” finalized, the investors who wound up actually executing their trades may then see the stock move against their intended price target. Meanwhile, the “spoofer” has cancelled the trade and taken a profit on the artificial stock price, by buying or selling the security based upon intended market movement.
Marking the Close
When a market manipulator buys a security at the close of the trading day, and pays more than the bid level, or the asking price of the security, that manipulator could be “marking the close.”
As the price of a stock at day’s end is usually a reliable marker for the investment’s price performance going forward, other investors often jump in and buy the stock. The market manipulator leverages the gain and locks in a profit by quickly selling the stock once its price moves upward.
Recommended: 5 Investment Strategies for Beginners
How to Avoid Market Manipulation
It’s not always easy to see the “red flags” that signal an active market manipulator. However, beginner investors who are aware of common scams may be able to avoid falling victim to their scams.
Invest for the Long Term
Since market manipulators often profit from day-to-day stock movements, investors with long-term portfolios, who don’t engage in market timing, are largely insulated from the impact of market manipulators’ schemes.
Avoid Penny Stocks
Penny stocks, nano stocks, and micro-cap stocks are often the lowest priced securities on the market and are often low-float stocks, which makes them highly volatile and more vulnerable to the price movements engineered by market manipulators.
Larger stocks, on the other hand, such as mega-cap stocks, are less vulnerable to market manipulation due to their trading volume and the level of public scrutiny that they are subject to.
Conduct Due Diligence
When alerted to a potential research report, Internet chatroom or social media comment, or other sources of potentially false or misleading news, resist the urge to immediately trade on the information. That’s exactly what market manipulators expect investors to do, and they profit from impulsive market actions.
Instead, stay calm and do your research to see if there’s any validity to the news–or red flags to indicate manipulation.
Know the Scams
Awareness of schemes such as pump-and-dump or spoofing can make it easier for you to spot them in action.
The Takeaway
Market manipulation is the act of artificially moving the price of a security and profiting from that movement. Even sophisticated investors can fall victim to market manipulation, but understanding how such schemes work can help you spot and avoid them.
Knowing the basics of market manipulation, and how to sidestep it (if possible) can be another tool in an investor’s toolkit. It’s also worth noting that regulators are on the hunt for it, too. If you have further questions, it may be beneficial to speak with a financial professional.
Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
FAQ
What is the criminal punishment for market manipulation?
Potential punishments for market manipulation depend on the specifics of the crime, the charges, and a potential conviction, but they can involve hefty fines and many years in jail, in some circumstances.
How do big investors manipulate the stock market?
It’s possible that some bad actors spread rumors or false news about market movements in an attempt to influence sentiment, spoofing the markets, or engaging in pump-and-dump schemes.
How do short sellers impact stock prices?
It’s possible that short sellers can drive the value of a stock down, improving the short sellers’ positions, in the short-term.
Photo credit: iStock/HAKINMHAN
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.
Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
SOIN-Q325-026