Because the function of the stock market is to set fair prices for securities based on publicly available information, market manipulation is a perpetual concern for investors.
Artificial manipulation of prices by malicious actors can distort valuations and saddle everyday investors with steep losses. Is there manipulation in the market and how do big players manipulate the stock market? Here is a list of ways share price can be influenced:
One of the simplest market manipulation techniques is the deliberate spreading of misinformation about a particular stock to drive the price up or down.
The more modern name for this phenomenon is fake news, though it is also referred to as a false market. This type of manipulation requires little capital and can be done by any individual or group with sufficient reach.
The false information involved in this kind of scam can take many forms. In some cases, it can involve falsified reports or financial statements purportedly from the target company. In others, false news stories about the company will be spread to drive investor sentiment in a specific direction.
A pump-and-dump scheme is very similar to creating a false market. While false markets can drive stocks either up or down, though, a pump-and-dump scam involves an investor or group buying a specific stock, driving the price up with false information and then selling it to realize a profit.
Pump-and-dump scams can employ a variety of different tactics to convince investors to buy the overhyped stock. In some cases, the people hyping up the stock are company insiders or notable institutional investors whom the market will readily follow.
In other cases, the actors behind the pump-and-dump will use seemingly legitimate third-party websites, media outlets or newsletters to build up market enthusiasm for the target stock.
Generally, these schemes play on fear of missing out to convince investors to make unwise financial decisions without conducting due diligence.
Spoofing involves the use of large orders that are never executed to artificially move the price of a stock.
In spoofing, an investor or group of investors will place a large number of orders above or below the current price of the targeted stock.
Before those orders are executed, the same investor places a corresponding set of orders on the other side of the market. Prior to the first set of orders can be executed, the investor will cancel them and keep the profitable second set of orders.
The same idea can also be employed in a variant of spoofing known as layering. In layering, a trader places large orders at a variety of different price points on either side of the current market price.
Whichever way the market moves, the trader will cancel the unprofitable orders, retaining only the profitable ones. While moderately more complex, layering manipulates the price of the stock using the same basic mechanism as spoofing.
In wash trading, a single investor both buys and sells shares of a company’s stock from separate accounts to artificially inflate that stock’s trading volume.
As a result, the broader market may take an interest in the stock. The original trader, knowing that the price has been driven up by artificially high trading volumes, can then sell the inflated shares or short the stock and profit when the market corrects downward.
It’s worth noting that wash trading can also be used for the purposes of unfairly claiming additional tax deductions on stock market losses. For this reason, the IRS prohibits deductions on losses if an investor repurchases substantially similar securities within 30 days of selling a stock.
A bear raid is a scam in which a group of short-sellers collude to drive down the price of a stock.
Generally, this is accomplished with the spreading of false negative information about the performance of the target business while the participants ramp up the stock’s total short interest. Bear raiding is often done to small-cap companies that are already struggling, as investors are more likely to believe negative news about these businesses and sell their holdings.
It should be noted that short sellers must specifically be colluding and spreading false information in order to commit a bear raid.
When Bill Ackman launched his now well-known public short campaign against Herbalife, for example, his bullish counterpart Carl Icahn accused him of participating in a bear raid against the company.
Because the information Ackman presented was demonstrably accurate and his Pershing Square fund was the only party to the short position, however, Ackman was never investigated for or charged with market manipulation.
A final market manipulation scheme is known as a short-and-distort.
An inverse of the pump-and-dump, a short-and-distort involves an investor shorting a stock and then using false information to drive the price down.
The key factor that differentiates this tactic from a bear raid is the fact that a short-and-distort does not require multiple actors.
How Often Is the Stock Market Actually Manipulated?
While there are many hypothetical ways to manipulate the price of a stock, the evidence suggests that it’s relatively rare. Legal data from 2019 and 2020 record just 30 and 22 criminal cases related to market manipulation, respectively. Cases of manipulation may be more common among penny stocks, which are easier targets due to their low trading volumes and prices.
The rise of finance-focused social media content may, however, contribute to more widespread market manipulation going forward. In 2022, for example, the SEC charged eight Twitter influencers with securities fraud. The commission alleged that the individuals in question had collected over $100 million in profits by encouraging their followers to buy certain stocks, then selling when the prices rose due to the heightened trading activity.
So, while the broader stock market is rarely manipulated, it’s impossible to ignore the fact that malicious actors do artificially affect the prices of individual stocks in at least some cases. By understanding the tactics used by scammers while also conducting due diligence, investors can better protect themselves from being caught up in manipulated stocks.
The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.