Understanding market manipulation techniques

Market manipulation occurs when individuals or groups try to influence the price or perception of financial assets for their own benefit. While financial markets are typically designed to be transparent, some players use tactics that mislead investors, skew market values, and undermine trust. In this article, we’ll break down the most common market manipulation techniques, how they work and what you can do to spot and avoid them.

• Market manipulation involves intentional actions to distort financial asset prices or perceptions for personal benefit

• Common methods include wash trading, front-running, pump-and-dump schemes, layering and more

• These practices harm retail investors, undermine trust and disrupt the fairness of the market

• Awareness, critical evaluation of information and using secure trading platforms are essential to mitigate risks

What is market manipulation?

Market manipulation is the intentional act of inflating or deflating the price of an asset, creating artificial demand or supply, or otherwise distorting the natural price discovery process. These tactics can harm retail investors while benefiting those who use them.

However, the term "market manipulation" is sometimes confused with other related concepts, such as market making, market rigging and price manipulation. While these terms share certain similarities, they represent different aspects of market activity - some are legal and crucial for markets to work, while others are unethical or illegal. 

What is market making?

Market making is a legitimate process where traders or institutions provide liquidity by simultaneously placing buy and sell orders for an asset. This helps stabilise markets and ensures smooth transactions. Unlike market manipulation, which distorts prices for unfair advantage, market making promotes transparency and efficiency in the trading process.

What is market rigging?

Market rigging is a specific type of market manipulation that often involves collusion or coordinated actions to fix prices, limit competition or manipulate market conditions for unfair advantage. Ultimately,all instances of market rigging are a type of market manipulation and are therefore illegal. 

What is price manipulation?

Price manipulation is a subset of market manipulation and refers specifically to actions aimed at artificially changing the price of an asset. This includes creating false demand or suppressing supply to deceive investors into making decisions based on distorted information. Price manipulation is unethical and often illegal, as it distorts the natural price discovery process. However, there are certain instances where influencing prices is not considered illegal. These include regulated market-making activities, promotional pricing strategies or central bank interventions designed to stabilize markets. 

• Market manipulation: broad actions that distort the natural functioning of markets for unfair advantage

• Market making: a legal process that enhances liquidity and stabilises markets by providing continuous buy and sell quotes

• Market rigging: an illegal activity involving collusion to control market conditions unfairly

• Price manipulation: a specific form of manipulation that targets an asset's price through artificial means

With a clearer understanding of the common terms related to market manipulation, let’s delve into the specific techniques used and how to identify them.

What is wash trading?

Wash trading is a deceptive trading practice where the same person or group buys and sells the same asset to create the illusion of high market activity. It’s used to trick other investors into thinking there is significant demand or supply for the asset.

• A person (or group) places both buy and sell orders for the same asset at the same time to mimic real trading activity 

• These trades are typically executed between accounts controlled by the same party, creating a false sense of market demand or supply

• This orchestrated activity misleads other investors into believing there is genuine market interest, prompting them to trade based on false data

Warning signs of wash trading

• Unusual trading volumes: extremely high volumes without any corresponding market news or demand increase

• Repetitive trade patterns: identical buy and sell orders for the same asset within short timeframes

• Price stability amid high volume: high trading activity with no significant change in the asset's price

What is front-running?

Front-running is an unethical practice where someone with insider knowledge of a large, upcoming trade takes advantage by placing their own trades ahead of it. This allows them to profit from the predictable price movement caused by the larger trade.

• A trader, broker or algorithm identifies a large order about to be placed in the market

• The individual or system executes their trade first, knowing the large order will influence the price

• Once the large order impacts the price, the front-runner sells or buys to capitalise on the expected market movement

Warning signs of front-running

• Sudden, unexplained price movements: sharp price changes that occur just before a large order is executed

• Unusual trading patterns: trades that appear to exploit insider knowledge or take advantage of market inefficiencies.

What are pump-and-dump schemes?

A pump-and-dump scheme is a type of fraud where manipulators artificially increase the price of an asset by spreading misleading information. Once the price is high enough, they sell their holdings, causing the price to collapse and leaving other investors with losses.

• The schemers buy large amounts of a low-value asset

• They spread false or exaggerated positive information to drive up demand

• Once the price peaks they sell off their holdings, causing the price to crash

Warning signs of pump-and-dump schemes

• Sudden, rapid price increases: unexplained spikes in price without any credible news or market developments to justify them

• Unverified social media endorsements: prominent promotions or exaggerated claims shared on social media without reliable sources

What is poop and scoop?

Poop and scoop is a market manipulation tactic where false negative information is spread about an asset to lower its price. Once the price drops, the manipulator buys the asset at a bargain, benefiting when its value rebounds.

• The schemers initiate this tactic by spreading negative rumours or false claims, creating fear and uncertainty among investors, which leads to a sharp decline in the asset’s price

• Once the price is artificially pressed, the manipulators exploit the situation by acquiring the undervalued asset, positioning themselves to gain significant profits when its value recovers

Warning signs of poop and scoop

• Sudden waves of negative news: unverified rumours or negative reports about an asset circulating without credible sources

• Sharp price declines: significant drops in price without any corresponding market events or fundamental reasons

What is layering?

Layering is a tactic where traders place fake buy or sell orders to create the appearance of market interest. These orders are cancelled before execution, tricking other traders into making moves based on false signals.

• Manipulators strategically submit large buy or sell orders that they never plan to fulfil, creating an illusion of strong market interest or pressure to influence other traders' behaviour

• After tricking others into acting on the fake orders, the manipulators cancel them, leaving other traders at a disadvantage

Warning signs of layering

• Flashing large orders: significant buy or sell orders that appear momentarily and disappear before they can be filled

• Repeated order cancellations: consistent patterns of cancelled orders that seem designed to influence price direction

What is spoofing?

Spoofing is a manipulative trading practice where traders place fake buy or sell orders to deceive others into making decisions based on false market signals. Unlike layering, which aims to influence the broader market by creating an illusion of widespread demand or supply, spoofing often targets individual traders, tricking them into reacting to short-term price movements.

What is shilling?

Shilling is when someone promotes an asset for their personal gain, often under the guise of unbiased advice.

• Influencers or individuals with vested interests create hype around an asset to drive up its demand and price

• Often, these promoters are paid or stand to gain directly from the asset’s price increase

Warning signs of shilling

• Public figures or influencers excessively promote an asset without openly revealing they have been paid or incentivised to do so

• Coordinated efforts on social media platforms aimed at generating unwarranted hype and enthusiasm for a specific asset

How big companies manipulate the market

Market manipulation isn’t always carried out by rogue traders or criminals - sometimes, it’s the actions of large, well-known corporations that shape markets in unfair ways. Large corporations can manipulate markets using strategies like strategic misinformation, predatory pricing and insider stock buybacks. They may release exaggerated projections or delay negative news to influence stock prices, use predatory pricing to eliminate competition or conduct stock buybacks to artificially inflate share values. 

For example, Tesla’s CEO Elon Musk’s 2018 tweet about taking the company private at $420 per share temporarily boosted Tesla’s stock price, but the unconfirmed claim caused volatility. These tactics can distort markets, often leaving retail investors at a disadvantage.

How to protect yourself from market manipulation

Now you are aware of the most common market manipulation techniques and their warning signs. Armed with this knowledge, you can take proactive steps to protect yourself by following these simple best practices:

• Stay informed: learn how these schemes work

• Verify information: use credible sources for market data

• Diversify investments: spread your risk across different assets

• Avoid emotional decisions: don’t act on hype or fear

• Use trusted platforms: trade on secure and transparent exchanges like Bitpanda

Staying safe also requires staying informed about the latest developments and deepening your understanding of how scams operate. The Bitpanda Academy offers many resources to help you stay secure in the crypto world, covering the biggest risks in investing and more.