Market Manipulation

Lesson

Market manipulation refers to the unethical and illegal practice of artificially influencing a security's price or trading volume to create a false or misleading appearance of market activity.

Practice Question #1

Which of the following is an example of market manipulation?

A) Arbitrage

B) Market timing

C) Pump and dump

D) Market making

Select an option above to see an explanation here.

A) Arbitrage is a legal and common practice in financial markets. B) Market timing is a legal investment strategy. C) Pump and dump is a form of market manipulation in which a stock is promoted and sold for a profit. D) Market making is a legitimate and necessary function of market participants.

Terms

Market manipulation:: The act of artificially influencing a security's price or trading volume to create a false or misleading appearance of market activity.
Pump and dump:: A scheme in which an individual or group promotes a stock they hold, causing the price to rise, and then sells it for a profit.
Wash trading:: A form of market manipulation in which an investor simultaneously buys and sells the same security to create the appearance of increased trading volume.
Front running:: The unethical practice of a broker executing orders on a security for their account before filling orders for their clients.
Spoofing:: The act of placing a large order to buy or sell a security with no intention of executing the order to manipulate the market price.
Churning:: The excessive buying and selling of securities in a client's account by a broker to generate commissions.
Cornering the market:: The act of acquiring a significant enough position in a particular security or commodity to manipulate its price.
Painting the tape:: A form of market manipulation in which transactions are coordinated to create the appearance of increased trading volume.
Regulation M:: A set of SEC rules to prevent market manipulation during securities offerings.

Practice Question #2

What is the primary purpose of Regulation M?

A) To prevent insider trading

B) To prevent market manipulation during securities offerings

C) To regulate market makers

D) To regulate the use of margin in securities transactions

Select an option above to see an explanation here.

A) Insider trading is regulated under other rules and regulations. B) Regulation M is designed to prevent market manipulation during securities offerings. C) Market makers are regulated under other rules and regulations. D) Margin requirements are regulated under other rules and regulations.

Historical Example

In the late 1990s, a group of individuals orchestrated a pump-and-dump scheme involving a small technology company. They spread false information about the company's prospects, causing the stock price to soar. Once the price peaked, the group sold its shares, causing the stock to plummet and leaving unsuspecting investors with significant losses.

Practice Question #3

Which of the following practices involves a broker executing orders on a security for their own account before filling orders for their clients?

A) Churning

B) Front running

C) Spoofing

D) Wash trading

Select an option above to see an explanation here.

A) Churning involves excessive buying and selling of securities in a client's account to generate commissions. B) Front running is the unethical practice of a broker executing orders on a security for their account before filling orders for their clients. C) Spoofing involves placing a large order to buy or sell a security without executing the order to manipulate the market price. D) Wash trading is a form of market manipulation in which an investor simultaneously buys and sells the same security to create the appearance of increased trading volume.

Real-World Example

A trader places a large order to buy a security, causing other market participants to believe there is increased demand for the security. As the price rises, the trader cancels the order and sells their position at a profit, having manipulated the market price through spoofing.