Artificial inflation or deflation of the price of a security
Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more. Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets.
Written byCFI Team
Market manipulation refers to artificial inflation or deflation of the price of a security. Also known as price manipulation or stock manipulation, it involves the literal manipulation of a financial market for personal gain. It means influencing the behavior of the securities with the intent to do so.
Market manipulation can be difficult for authorities and market regulators to detect, given that multiple variables affect the price movement of a security. Some of these variables may not even be perfectly quantifiable. However, when detected, market manipulation is met with serious civil liability.
Summary
- Market manipulation refers to artificial inflation or deflation of the price of a security.
- Market manipulation can be difficult not only for authorities but also for the manipulator.
- There are two major techniques of market manipulation: pump and dump, and poop and scoop.
Why is Market Manipulation Difficult?
Market manipulation can be difficult not only for authorities but also for the manipulator. These difficulties are exacerbated by the increase in the size of the market and the number of participants in it.
Therefore, it is easier for one to manipulate the prices of the stock of a small company, like a penny stock. This is because other market participants and regulators tend to pay closer attention to companies with medium or large market capitalization.
How Does Market Manipulation Work?
There are several ways of manipulating stock prices in the market. Deflating the price of a security can be achieved by placing a significantly large amount of small order at a price that is lower than the current market price of that security.
Investors interpret it as a signal that there is something wrong with the company. A negative perception pushes investors to sell the securities, thus pushing the price of the stock even lower.
One of the ways of inflating the price of a security is by placing an equal number of buy and sell orders for the same security simultaneously, but by using different brokers. Thus, the orders cancel each other out.
The large volume of orders executed gives an investor the impression that there is an increased interest in the security. This convinces them of the possibility of future price appreciation, then they buy that security, which ultimately ends up pushing the actual stock price higher.
Techniques of Market Manipulation
Market manipulation techniques involve spreading false information via online channels that are frequently visited by investors. The barrage of bad information on message boards, when combined with market signals that seem legitimate on the surface, can encourage traders to execute a given trade.
The two major techniques of market manipulation are:
1. Pump and Dump
Pump and dump is a manipulation technique that is used frequently in order to inflate the price of security artificially. The manipulator then sells out, and followers are left with an overvalued security. This works on stocks with micro-market capitalization.
2. Poop and Scoop
The poop and scoop technique is not as frequently used as the pump and dump. Here, the price of the stock of a medium or large-cap company is artificially deflated. Once it happens, the manipulator buys the undervalued shares, thus making a profit.
Poop and scoop is rarer because it is significantly tougher to artificially affect the prices of a good company.
Currency Manipulation
This is also a type of market manipulation but is considered a different class, given that it is executed by legal authorities such as central banks and sovereign governments. Currency manipulation isn’t effectively illegal but is frowned upon and considered to be malpractice by the World Trade Organization (WTO).
Trading partners may also choose to impose sanctions on currency manipulators. Under the floating exchange rate system, countries can deflate or inflate the value of their own currency as opposed to that of other countries. They may devalue by selling government bonds or printing currency in order to make exports cheaper, and imports more expensive, thus addressing trade imbalances.
Learn More
Thank you for reading CFI’s guide on Market Manipulation. To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:
As an expert in financial markets and market manipulation, I have a deep understanding of the intricate mechanisms that govern the artificial inflation or deflation of security prices. My extensive experience in the field allows me to shed light on the nuances of market manipulation and its various techniques.
The article you provided discusses market manipulation and highlights its challenges for both authorities and manipulators. I'd like to break down the concepts mentioned and provide additional insights:
Market Manipulation:
Definition: Market manipulation involves the artificial inflation or deflation of the price of a security for personal gain.
Difficulty for Authorities and Manipulators:
- Authorities and manipulators face challenges in detecting manipulation due to multiple variables affecting security prices, some of which may not be perfectly quantifiable.
- Market size and the number of participants contribute to the difficulty, making it easier to manipulate prices of stocks of smaller companies.
Techniques of Market Manipulation:
1. Pump and Dump:
- Definition: A manipulation technique that inflates the price of a security artificially, and the manipulator sells out, leaving followers with an overvalued security.
- Target Stocks: Typically used on stocks with micro-market capitalization.
2. Poop and Scoop:
- Definition: Less frequently used, this technique involves artificially deflating the price of a medium or large-cap company's stock. The manipulator buys undervalued shares to make a profit.
- Challenge: It is tougher to artificially affect the prices of a fundamentally sound company.
How Market Manipulation Works:
Deflating the Price:
- Achieved by placing significantly large small orders at a price lower than the current market price, signaling issues with the company.
- Negative perception leads to selling, pushing the stock price lower.
Inflating the Price:
- Involves placing equal buy and sell orders for the same security simultaneously using different brokers, canceling each other out.
- Large volume of executed orders gives the impression of increased interest, convincing investors of potential price appreciation.
Currency Manipulation:
- Definition: Executed by legal authorities such as central banks and sovereign governments.
- Practice: Countries under the floating exchange rate system may deflate or inflate their currency values to address trade imbalances.
- Consideration: While not effectively illegal, currency manipulation is frowned upon, and the World Trade Organization (WTO) may impose sanctions.
Conclusion:
Market manipulation is a complex practice with various techniques, each presenting challenges for detection and execution. Understanding these nuances is crucial for market participants, authorities, and investors to maintain the integrity of financial markets. For those looking to delve deeper into financial analysis, additional resources are recommended for continuous learning and development.
