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Market Manipulation: An Overview for Retail Investors

By Brian O'Connell · July 26, 2021 · 4 minute read

We’re here to help! First and foremost, SoFi Learn strives to be a beneficial resource to you as you navigate your financial journey. Read more We develop content that covers a variety of financial topics. Sometimes, that content may include information about products, features, or services that SoFi does not provide. We aim to break down complicated concepts, loop you in on the latest trends, and keep you up-to-date on the stuff you can use to help get your money right. Read less

Market Manipulation: An Overview for Retail Investors

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.” Basically, 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 “undermines fair, honest and orderly 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.”

What Are Examples of Market Manipulation?

There are several methods that market manipulators use to push the prices of a security in the direction they prefer, creating investment risk for those who fall victim to their schemes.

Pump and Dump

The pump-and-dump scam is a common form of market manipulation. It occurs when a financial market participant who holds a specific investment knowingly issues false or misleading statements about the underlying company on social networking sites or other forms of media.

The goal is to “pump up” the stock with misleading information and artificially inflate the stock as buyers flock in, attracted by the false information provided by the market manipulator. The manipulator shorts the stock or waits for the optimal price point and then sells the stock before reality sets in, the information becomes known as false, and investors sell their holdings.

For example, in a pump-and-dump scheme, a market manipulator may start a rumor that a publicly-traded company is going to be bought by a larger company, which can quickly boost a company’s stock price. If enough investors buy into the rumor, more investors buy the stock, thus elevating the stock price.

Once the price hits a certain level, the market manipulators sell their shares of the stock and pocket a potentially significant profit. Those investors who don’t sell are left with a stock that could tank in price when investors realize the underlying company isn’t being bought out.

Recommended: An In-Depth Look at Pump-and-Dump Schemes

The “Wash” Method

In this form of market manipulation, an unscrupulous investor, or 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 that security’s 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” or “matched orders” enables a few investors to team up, actively buy and sell a security to paint a picture of a stock drawing interest in the market, and sell the stock for a profit as other investors jump aboard and drive the stock’s price upward.

Tape “Spoofing”

This form of market manipulation, also known as “layering,” 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.

Recommended: Spoofing in Trading: What Is It and How Does It Work?

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.

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 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.

With that in mind, you can start building your portfolio by opening an account on the SoFi Invest® brokerage platform, which allows you to purchase individual stocks, exchange-traded funds (ETFs), and even trade cryptocurrency. You can get started with an initial investment of as little as $5.

Photo credit: iStock/HAKINMHAN


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