Can Brokers Manipulate the Market? 5 Things To Know

As an investor, you’ll be curious to know what brokers, who have access to information, resources and knowledge, can or can’t do. After all, they’re at the forefront of the securities trade. What’s the extent of their power to manipulate the market?

Brokers can inflate or deflate the market for personal gain or to achieve a particular objective even though this is not that easy to do. Such manipulations can be quite hard to detect due to the various factors involved. Still, it’s not entirely impossible, especially with small company stocks. 

In the following paragraphs, we’ll explore the topic of market manipulation further, including the methods brokers often use.

Things To Know About Broker Manipulated Markets

The predetermined inflation and deflation of markets literally influences how the stock market behaves for personal gain. It is difficult for regulators and authorities to detect this manipulation because there are multiple variables involved, some of which may not be perfectly quantifiable. But when detected, the consequences of such machinations are dire.

Here is what you need to know about market manipulations:

1. Market Manipulation Is Not Easy

While detecting manipulation is never easy, it is also no easy task for the manipulator because of the number of participants and the market size. As such, it is much easier to adjust the prices of stocks in small companies, given that most of the attention is on the bigger players.

2. How Manipulation of the Market Works

Manipulating stock prices is carried out in various ways.

Among the most common techniques is placing large amounts of small orders, usually at a much lower price than the market price. Investors then interpret such actions as indicators that there’s something wrong with the organization. Everybody then rushes to dispose of their securities, thereby dragging the price further down. 

To inflate the price of a security, brokers place a matching number of buy and sell orders but use different brokers. The large volume of executed orders generates interest for the particular security and convinces many investors about a future appreciation. The decision to buy eventually pushes the price higher than it would be if the markets were left to their own devices.

3. The Techniques Market Manipulators Use

Brokers apply various techniques to manipulate the market.

Fake News

A popular manipulation technique involves disseminating false information through social networks frequently visited by the target audience. The incorrect information combines with the manipulated indicators to push traders to carry out specific actions.

Pump and Dump

A frequently used manipulation technique is pump and dump. The method inflates stock prices artificially, and then the manipulator sells out, leaving investors with securities at inflated prices. This manipulation method is typically more effective with small market capitalized stocks.

Poop and Scoop

Apart from pump and dump, manipulators can also use the poop and scoop method. The technique works by artificially undervaluing stocks, which the manipulator later buys at low prices to make a profit. However, Poop and scoop is not very common because it’s almost impossible to manipulate stock prices of a good organization.

Wash Trading

Through wash trading, the manipulator seeks to make a stock appear more active than it really  is. The stockbrokers may have multiple accounts to buy and sell the stock. They then repeat the buying and selling without actually making any profit in a bid to increase stock volume.

The main objective of wash trading is to ensnare investors by distorting the volume figures thereby affecting the price of the security. Wash trading mainly affects scalpers and day traders. Since the strategy is short-term, it does not affect long-term investors.

Bear Raid

Bear raiders are brokers that attempt to bring down the price of a security through various techniques such as spreading untruths about a company. The manipulator short sells before spreading false information, which causes others to sell or short, thus bringing down the stock prices and making a profit. 

Short selling can happen for legitimate reasons and is not illegal. For example, a firm may be in trouble, or the stocks may appear too risky to investors. Shorting under such conditions is bearish price action, and there’s nothing wrong with this.

Front Running

The front running method is also popular as a way of manipulating the market. Specialist manipulators leverage their knowledge and information on the incoming order-flow to limit the orders with front running. The result is monopolistic trading profits.

Naked Short Selling

Naked short selling is particularly popular with companies experiencing a declining price per share. The manipulation technique is a favorite of offshore brokerage firms, where local securities laws have no jurisdiction. This method is quite damaging to publicly-traded organizations.

A scam broker intentionally refuses to declare or disclose short positions with naked short selling. The broker borrows shares to conceal the short sale, but the purchaser never receives their stocks. The impact is dilutive and results in an unlawful increase in issued and outstanding shares and the decline of the predetermined share price.

The manipulator floods the market with cheap and non-existent stock and keeps the proceeds.

4. The Consequences of Market Manipulation

Market manipulation creates an unfair advantage for the manipulators, and it can destabilize the markets. Fewer people would enter the stock market if they knew that some people already have an unfair advantage, or that they would be taken advantage of. The result is little faith in the market, making it harder for organizations to raise capital.

5. Manipulating Currency

Currency manipulation belongs to a different class because the manipulators are typically governments and central banks. While currency manipulation isn’t strictly illegal, the World Trade Organization frowns upon it.

The consequences of currency manipulations are usually trading sanctions by trade partners. Under the floating exchange rate system, governments can print currency or sell government bonds to make imports more expensive and exports cheaper. The strategy addresses trade imbalances. 

Conclusion

Brokers can manipulate the market through various ways including spreading fake news, pump and dump, wash trading, front running, and naked short selling. The regulator or local authority may find it challenging to identify manipulation because of the factors involved. 

Whatever the case, small market capitalized firms are more vulnerable to manipulation than large organizations.

Sources

• Investopedia: How a Broker Can Avoid a Market-Maker’s Tricks
• The Balance: What Is Stock Market Manipulation?
• Corporate Finance Institute: Market Manipulation – Overview, How It Works, and Techniques
• Emerald: Types of Manipulation
• CFA Institute: Standard II(B) Market Manipulation
• Federation of American Scientists: Currency Manipulation: The IMF and WTO
• ResearchGate: In Pursuit of the Naked Short