When you become active in the stock market, you’ll take time to research the companies you’re interested in investing in and make an educated decision as to where you’ll invest your money. But what if the information you’re researching is incorrect? What if recent moves in a stock you’re interested in are nothing more than the result of stock market manipulation?
In short, you’ll lose your money!
When this happens, you may blame your brokerage, the stock market as a whole, or regulators. You may even decide that the stock market is too dangerous for your money after blaming yourself.
There’s no question that the true blame lies with the manipulators themselves, but there are a few steps you can take to avoid becoming the next victim and to report bad actors to make sure that your fellow stock market participants are protected as well.
What Is Stock Market Manipulation?
In short, stock market manipulation is the artificial inflation or deflation of stock prices as the result of deliberate actions taken by stock market manipulators.
For example, let’s say that someone owns 100,000 shares of XYZ stock that they purchased at $3.50 per share. The average investor would wait for organic share price growth and sell when they believe they’ll get the highest price.
A stock market manipulator thinks differently about this process. Instead of patiently waiting, the manipulator may disseminate false information, spread rumors, or use a host of other tactics in an attempt to artificially inflate share prices. Often, these manipulators release rumors surrounding acquisitions, product launches, or contracts that never actually took place. However — especially in the world of penny stocks — this type of news has the potential to result in gains in multiples.
Once share prices have risen to the point where the manipulator believes that it’s time to cash in, they sell large blocks of shares, making a profit while sending the stock price tumbling and saddling the other unsuspecting investors with significant losses they may never recover.
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Types of Stock Market Manipulation
Stock market manipulation, like other forms of scams, comes in various shapes and sizes. Some of the most common scams that stock market manipulators run include:
1. Pump-and-Dump Schemes
A pump-and-dump scheme is by far the most common scam in the stock market. This is the kind of scheme explained in detail above, in which a scammer buys shares of a stock, disseminates false information that leads to a rise in its value, and then sells at the top to take profits, ultimately stealing from unsuspecting investors.
2. Stock Promoters
Stock promotion is not illegal, but it’s highly frowned upon by investors, many of whom believe it to be a form of stock market manipulation.
The scheme usually takes place among penny stocks and starts when management at a publicly traded company believes their shares are undervalued and their stock lacks liquidity. In order to raise prices and alleviate liquidity concerns, some publicly traded companies will hire stock promoters.
These promoters are often paid tens or even hundreds of thousands of dollars. Once hired, stock promoters disseminate positive information on their websites, on social media, and on message boards across the web. The idea is that when investors read these overly positive opinions, they will feel the fear of missing out, or FOMO, and buy the stock.
This process is not illegal as long as disclosures are provided on the content explaining that it was paid for. However, stock promotion is looked down upon in a big way, and for two good reasons:
- Short-Term Movement. Stock promotion generally leads to short-term price appreciation and gains in liquidity. Once the promotion is over, the fizzle fades and the stock will generally fall back to where it was prior to the launch of the promotion or even lower, significantly costing those who purchased shares as a result of the promotion.
- Cash. The vast majority of companies that take part in stock promotion are cash-strapped. Promotion is generally used to raise prices in order to get a better deal when raising funds through the sale of newly-issued shares, which ultimately rob existing investors of value through heavy dilution. In these cases, promotion serves as a roundabout way of getting unwitting individual investors to pay for the added cash flow to the company.
3. Dissemination of False Information
This is another form of highly illegal stock market manipulation. However, legality doesn’t always stop con artists; if it did, scams wouldn’t exist.
In financial markets, the validity of information is overwhelmingly important. After all, news from a publicly traded company or from large investors associated with a publicly traded company has the potential to lead to significant movement in stock prices.
In some cases, a company’s management team will attempt to hide negatives through the dissemination of false information through a press release, SEC filing, or other means. This is also done by stockbrokers looking to earn a commission on the sale of stock.
Once the false information is shared with the investing community, retail investors tend to latch on, buying shares and sending the stock higher. Although this does lead to improved trading activity, false information is often disproven, and the stock tanks when that takes place.
The best example of the carnage that can result from the dissemination of false information is the Enron scandal, which ultimately resulted in countless investors losing significant amounts of money, many of whom were unable to retire as a result of their losses.
4. Heavy Short Selling
Short selling, or shorting, is a process that is legal, but many believe that it shouldn’t be, because it often leads to value being robbed from existing investors, especially in cases when stocks experience high levels of shorting.
Short selling is a relatively simple process. When an investor believes that a stock’s valuation is going to fall, instead of investing in the traditional sense by buying stock, they “short” the stock.
This means that the investor goes through their broker to borrow shares held in other investor accounts. These shares are then immediately sold in the open market at the current price. If the stock price falls, the short seller buys the borrowed shares at lower prices in order to return the stock to the account from which it was borrowed.
Although short selling is a normal and legal activity in the stock market, high levels of coordinated shorting can lead to significant declines in the value of the stock, resulting in significant losses for those caught in the scheme. To make matters worse, short sellers sometimes disseminate false information in an attempt to drive share prices lower, increasing their profits at the expense of the investing community.
5. Federal Reserve Changes to Interest Rates
One of the biggest stock market manipulators out there is the U.S. Federal Reserve. That’s right, the private bank charged by the federal government with controlling rates of inflation and balancing the U.S. economy is one of the biggest manipulators of the stock market.
The Federal Reserve controls what’s known as the federal funds rate, or the base interest rate charged to banks when they borrow money. When the fed funds rate is low, money is more widely available, generally leading to improvements in the stock market and often widespread bull markets.
Conversely, when the fed funds rate is high, money is more expensive to borrow, meaning that it’s not quite as easy to come by. During these times, consumers are less likely to spend money or purchase new homes or cars. Instead, they will generally keep their money in the bank in order to take advantage of the higher interest they’re being paid. As a result, a high fed funds rate generally leads to market declines and often widespread bear markets.
If the idea of central banks manipulating the market doesn’t sit well with you, you’re not alone. In fact, the idea of cryptocurrency was born as a result of the control that central banks have over their respective economies and the stock markets that fuel them. Many believe that the world needs decentralized currency, leading to a flood of interest in Bitcoin and other cryptocurrencies not controlled by central banks.
What Do Manipulators Get Out of It?
The benefit to stock market manipulators is simple — it’s a fast payoff, albeit an illegal one.
Using the example above, the manipulator purchased 100,000 shares of XYZ stock at $3.50 per share. After purchasing shares, the manipulator moves forward with the scam, launching a series of social media posts, paid articles on websites, and email blasts announcing (falsely) that the company is in talks to be acquired by a big player within the sector.
As the fraudulent news starts to make its rounds, the stock might climb from $3.50 per share to $7 per share virtually overnight. At the $7 per share price, the manipulator begins selling shares, doubling their money before the wider market is even aware of what’s happening.
Soon, savvy investors start to notice the large sell order, but by then it’s too late; once they realize the good news was false, investors in the stock go into a frenzy, ditching their shares as quickly as possible and sending share prices back to $3.50 — or lower.
In these types of schemes, known as pump-and-dump schemes, the scam leads to tremendous gains for the manipulator while robbing unsuspecting investors of their hard-earned money.
Who Protects Investors?
First and foremost, you should protect yourself from stock market scams. This can be done by doing adequate research and following the tips below. However, protecting yourself from fraudsters is not all on your shoulders. In fact, there’s a government agency known as the Securities and Exchange Commission(SEC) that’s charged with maintaining fair and orderly activities in the stock market.
The SEC was created in 1933 after the stock market crash of 1929 led to the Great Depression. During this time, scams ran rampant in the stock market, which had little by way of oversight.
Due to the heavy economic impact of these scams, the U.S. government knew it had to do something. It created the Securities and Exchange Commission to ensure that the actions that led to one of the world’s largest financial crises would never take place again.
Today, the SEC constantly combs the market looking for fraudsters and taking action by issuing fines, recovering ill-gotten gains, and barring con artists from working in the securities industry or holding management positions at publicly traded companies.
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How to Protect Yourself
The Securities and Exchange Commission is charged with protecting stock market participants from unsavory activities on Wall Street. Although they do a great job, the SEC is only so large, and it simply doesn’t have the workforce or resources to catch every scam that takes place before they affect the investing community.
The good news is that by taking advantage of the tips below, you are the only tool you need to protect yourself from potentially significant losses at the hands of stock market manipulators.
1. Verify What You Hear and Second Guess What You See
Research is the basis of any quality investment decision. However, due to the dissemination of false information, research can often steer you in the wrong direction. As such, it’s important to verify everything you hear and second guess everything you see.
For example, if you see a message on social media that a company is in talks to be acquired by a larger company, you may be tempted to buy the smaller company’s stock in order to realize the gains that are often associated with acquisitions.
Before making the investment, it’s important to look for press releases or SEC filings issued by both the company that’s supposed to be acquired and the company rumored to be the buyer in the acquisition. Check reputable market news and analysis sites for word of the acquisition before you believe it.
If you can’t find any evidence that the company is actually in talks to be acquired, don’t buy the stock. You may have found a pump-and-dump scheme or another form of stock market manipulation.
2. Look for Disclosures
Any time a company pays for an article or video to be developed on its behalf, a disclosure must appear on the page where the article or video is shared. Informational companies that have nothing to hide will make this disclosure clear, often written out clearly at the top or bottom of the article.
However, a promoter whose only interest is to increase valuations and liquidity will attempt to hide these disclosures, often placing them in the footer of the website, below mailing list sign-ups, comments, ads, and other content the average reader isn’t interested in scrolling through.
When doing your research, make sure to scan the whole page you’re on when you find positive information. Looking for the fine print will ensure that you’re aware of any promotional activities.
If you find a hidden disclosure, avoid that stock like the plague. Also, even if the disclosure isn’t hidden, look for the price paid by the company. If the price is $30,000 or more, there’s a strong chance that what you’re reading is heavily promotional and not designed to be purely informational.
These are clues that a company is paying for price appreciation and liquidity, often in hopes of raising funds at the cost of existing investors. These are stocks that you should avoid.
3. Look Into Short Interest
Heavy levels of short selling often result in significant declines in the value of a stock. High levels of short selling are also indicative of something wrong that is leading to investors losing interest in the stock.
You can find information surrounding short interest on Yahoo! Finance for any stock under the statistics tab. Most stock screeners and trading platforms include this information somewhere. Short interest in a particular stock is often presented as a percentage of the total number of shares, also called float.
If the short volume ratio is over 10%, it’s best to stay away from the stock unless you are a seasoned investor who understands the risks associated with investing in stocks that are heavily shorted.
For the vast majority of investors, diversification is a crucial piece of their investing strategy, and for good reason. Diversification protects investors from significant losses associated with manipulation as well as all other risks associated with the stock market.
Diversification is the process of spreading your investment dollars across a wide range of stocks, ETFs, mutual funds, hedge funds, or other investment vehicles. Many investors use the 5% rule — limiting any single investment to 5% of your total portfolio —to guide them toward solid diversification and an asset allocation that minimizes the risk of any one investment being a bust.
5. Steer Clear of Penny Stocks
Stock market manipulation generally takes place among penny stocks, and for good reason. Smaller stocks with low market caps are far easier to manipulate.
Think about it — if a company only has a market cap of $50 million, it most likely has a smaller number of shares available to the public, also known as float. With fewer shares available, spurring enough interest in the stock to cause significant gains is a relatively simple process.
As such, it’s best for beginner investors to stay away from penny stocks and focus on large companies with a solid history of growth, dividends, or a mix of the two.
6. Keep an Eye on the Federal Reserve
Changes made to monetary policy by the Federal Reserve have a vast impact on the U.S. stock market. As such, it’s important to keep an eye on what the Fed is doing.
Although there’s no way to stop the manipulation of the market by the Fed, knowing what they are doing gives you the ability to respond and protect your investment portfolio by adjusting your holdings when Fed policy and interest rates change.
7. Use Common Sense
There’s an old saying that is no more true anywhere than in the stock market: “If it sounds too good to be true, it probably is.”
If you come across an overly positive article or video about a stock that seems to go against the opinion of the overall investing community, it’s likely a promotion. If a stock that should be doing well remains flat or is experiencing significant declines, short sellers are likely holding prices down.
Ultimately, if something doesn’t seem right, trust your research and the educated opinion it resulted in, and look for other opportunities rather than letting the fear of missing out guide your investment decisions.
How to Report Market Manipulation
Again, the Securities and Exchange Commission simply doesn’t have the resources to catch every stock market scam as it happens in real time. That’s where you come in.
The regulatory agency depends on tips from investors like you who smell something fishy in the air. If you believe securities fraud or other wrongdoing is taking place, you can report the activity to the Securities and Exchange Commission.
Keep in mind that the SEC covers all kinds of wrongdoing. So, if you come across other stock market scams like Ponzi schemes, high-yield investment programs, or pyramid schemes, you can use the SEC website to report the scam and protect your fellow investor and the national economy.
The vast majority of investors are great people. They live, they laugh, they love, and they harm no one in the process. However, there are also bad apples, and as long as there are opportunities for bad apples to make a quick buck, there will be manipulation in the stock market.
Using the guide above, you will be well-prepared to protect yourself from this manipulation through research, verification, and common sense. Moreover, you’ll have the ability to protect your fellow investors and the foundation of the national economy by blowing the whistle when you spot wrongdoing.