Market Manipulation

Celticheart Investor

A beginner's guide to trading and investing

Now this is one of those contentious areas that always polarises opinion, does market manipulation actually exist or is just another conspiracy theory? Well the truth is it does exist and has done for a long time in one form or other, the problem is that with today's computer based trading it has become a lot more sophisticated, much of it generated by algorithms that don't require a person to action the trades individually.

I for one believe that market manipulation has now becoming so widespread, particularly in small caps markets such as  the Alternate Investment Market or AIM, (Formerly the Alternate Investment market) that it is a major threat to the continuation of these markets. The very nature of this market is high risk / high reward which means that it attracts a lot of short term traders, the very people who have most to gain from manipulating the share price, both up and down.

"Investopedia" gives the definition of Market Manipulation as being: "The act of artificially inflating or deflating the price of a security". Market manipulation is in fact illegal but it is much easier to manipulate the share price of smaller companies (penny shares) because they are not as closely watched by analysts as their larger counterparts on the main markets.

There are several well known techniques used by traders that could be regarded as manipulation so let's look at some of these:

Churning: This is the term used when a trader places both buy and sell orders simultaneously or at roughly the same time. This creates the illusion of greater stock movement intended to attract new investors fueling demand for the stock resulting in an increase in price.

Wash Trade:  Similar to Churning but over an extended period of time, intended to make it appear that there is a greater volume of stock being traded with the intention of drawing investor interest to the share.

Pools: An arrangement between a group of traders to delegate authority to a single manager to trade in a specific stock for a specific period of time and then to share in the resulting profits or losses, should they occur

Bashing: An activity that many of us on the small caps markets have experienced first hand. This tactic is frequently implemented by online message board posters (Bashers) who post false or misleading information about a company in an attempt to get shares for a cheaper price. The posters sometimes work directly for unscrupulous companies who have convertible notes that convert for more shares the lower the bid or ask price is. If the Bashers can drive a stock price down by trying to convince shareholders they have bought a worthless security, the more shares the company receives. 
Once the stock conversion is completed those same posters, often with new identities become positive about the stock and talk the price back up. 

Pump and Dump: This scheme is so blatant at times it is astonishing that it works at all but such is the nature of smaller retail investors that the pursuit of what they see as potentially huge gains blocks out rational thinking. The way this generally works is through rumour, sometimes generated on public forums or bulletin boards but equally by unscrupulous tipsters in the media. False or misleading information is generated which creates a frenzy of buying (The pump) which artificially drives the price up, often way beyond the company's true worth. Once the target price is reached the perpetrators sell their shares (the "Dump") and the stock price falls like a stone, the unwary investors see the sudden drop and rush for the exit driving the share price into freefall.

Bear raid: Pushing the price of a stock down by heavy selling of equities, when this is done by someone that does not currently hold any shares it is called Short selling as they are in fact "borrowing" stock with the intention of buying back later at a lower price to fulfill the original "Sell" trade.

It is not only traders that can manipulate the markets, Market makers (or MMs) are also known to occasionally move the price down to trigger stop losses or increase the spread between Bid and Ask prices to influence directional movement of the share price. Whether this is within their remit as a Market Maker or something more devious is questionable in my opinion.

The implementation of the Market Abuse Directive (MAD) in 2005 resulted in an EU-wide market abuse regime and a framework for establishing a proper flow of information to the market, see link below for the full article.

http://unavista.londonstockexchangegroup.com/articles/market-abuse-directive-mad-ii-overview/

Recently, there have been a number of instances where the companies themselves have taken legal action against individuals and groups who are believed to have participated in libelous or manipulative practices. 

A cautionary note, trading and investing in shares carries a level of risk, these blogs are only meant as a basic guideline to investing and trading, always do your own research and base your decisions on what you can afford to lose. This blog is not intended to provide financial advice as I am not qualified to do so, it is simply designed to provide information about how the markets work that might be of some help to private investors like myself.