Market Manipulation: How It Works.

“Market manipulation?” You want market manipulation? I’ll give you market manipulation.

There are two main families of market manipulation: information-based and trading-based. They’re often used in concert but, at issue in the ongoing Gamestop (NYSE: GME) related controversy is trading-based manipulation, sometimes called “painting the tape.”

Generally, any trading that isn’t done in good faith as part of an investment strategy, but rather to create action that looks like something it isn’t is market manipulation. The most common form is some variation of “The Box.”

The Box

It’s usually a group effort that starts with an amount of money and stock being contributed by various parties into The Box. The money in The Box is then used to buy the stock in The Box, on the market, over and over, at higher and higher prices, painting volume and price on the tape as it goes.

The Box is a self-contained ecosystem, theoretically, because money is used to buy stock off of the offer, which is then offered up again at a higher price, and bought back again with the same money that bought the first stock. If done correctly, the fraudulent action makes it look like buyers are anxious for the manipulated stock, and brings in genuine buying to chase the fake momentum and create a market for the cheap stock that the box contributors did not put in the box.

Somehow, when it comes time to un-pack the box, the contributors tend to end up with less stock and money than they put in, the thermodynamics of stock hustles never allowing for total efficiency.

The Box is not to be confused with standard market-making, which is meant to keep a lid on volatility, and is perfectly legal. A legal market maker is usually a registered securities professional contracted by the company to use stock and money to keep a market orderly. Pro market makers playing by the rules never use the money to buy the stock or otherwise self deal. They just maintain a reasonable lineup of bids and offers so that the stock looks like something worth trading.

It’s among the professionals tasked with market making that we sometimes find cases of:

Order Spoofing and Layering

The Dive covered spoofing and layering in a two part “How it Works” back in October that started with a detailed rundown of JP Morgan’s spoofing of orders to manipulate the gold market, and ended with a look at known spoofing and layering cases in Canadian small cap markets. The playbook here involves putting up fake bids or offers – usually in the pre-market – to create an appearance of large sellers or buyers, then pulling those orders before there is an opportunity for them to be filled.

While those are the most common methods of trading-based market manipulation, there are all sorts of inventive ways to make the tape tell a lie. The common thread among them are trades or orders that are not being honestly placed or executed for the purpose of buying or selling securities.

Then came Reddit

One day, retail traders figured out en-masse that if they all buy the same stock, that stock will go up, and the momentum in its ascent was likely to bring in other buyers who also want the stock to go up, so they did, and it did. Now, as the stocks of dying retail businesses get bought into oblivion, the financial establishment, through the financial media, are loudly and deeply worried about a phenomenon over which it has no control, and is demanding that regulators do something about this blatant stock manipulation! But is it manipulation, really?

The redditors crowding into these trades and the money crowding in behind them aren’t placing fake orders or pulling a bait-and-switch on the bid; they’re buying the stock with green money for the only real reason anyone has ever bought a stock: they wanted it to go up, so that they could make money. And it did go up! They did make money! Capitalism worked!!

But it isn’t supposed to work for them. Regulators have since leaned on platforms and exchanges to choke off access to the high-short-interest meme stocks that have taken over popular culture, under the auspice of preserving a market in which stocks reflect the value of the business whose equity they represent, as if they ever did or will.

The financial establishment should be careful what it wishes for.

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Information for this briefing was found via Sedar and the companies mentioned. The author has no securities or affiliations related to this organization. Not a recommendation to buy or sell. Always do additional research and consult a professional before purchasing a security. The author holds no licenses.