What is Manipulation in the stock market?

The idea behind investing in the stock market is simple: you buy shares at a lower price and sell them at a higher price. However, numerous entities in the stock market are capable of manipulation in the stock market. These entities deceive the uninformed investors and use their investment to increase or decrease the price of securities. The process is called market manipulation. For an investor, it is vital to understand the topic in detail to ensure utmost investment protection.

What are shares, and how is the share price determined?

A share indicates a unit of ownership of a particular company. If you own shares of a company, it implies that you, as an investor, own a percentage of the issuing company. These shares are listed on the stock exchanges through an Initial Public Offering, and investors can buy and sell them based on their current price. If you buy the shares of a company, you become the owner of the company in the proportion of the percentage of the purchased shares. As a shareholder, you are entitled to receive a portion of the profit of the company, called the dividend.

Shares of every publicly listed company are traded on the stock exchanges such as the National Stock Exchange and the Bombay Stock Exchange. The prices of the shares fluctuate continuously based on the demand and supply factors. If the demand for the shares of a company is higher than the supply (fewer people are selling and more are looking to buy), the share price increases. On the other hand, if the supply of the shares is higher than the demand (fewer people are buying and more are selling), the share price decreases. If any event is positive, such as good revenue, profitability etc., investors feel optimistic about the company and buy its shares, contributing to the demand; if not, they sell and increase the supply.

What is Manipulation?

Stock market manipulation is conduct or technique used by stock market entities to fool the investors by artificially affecting the prices of securities. These entities undertake various measures to falsely increase or decrease the demand for the securities to represent them as a profitable investment even when they know securities to be fundamentally flawed. Almost all the entities indulge in market manipulation for personal gains and exit their positions when their predetermined goals are achieved.

For market regulators such as the Securities and Exchange Board of India, detecting market manipulation is difficult. As numerous other factors affect the price of the securities, all the factors are impossible to quantify, leading to a gap in identifying market manipulation. However, in the case market manipulation is detected by SEBI, the entities can face serious civil liabilities such as a securities market ban, jail term or a heavy fine.

How does Market Manipulation work?

When trading or investing in the stock market, it all comes down to the price of the security. Entities included in market manipulation try to artificially affect the demand or supply of the security such that investors with less knowledge find the security as a viable investment.

For example, market manipulators would want the price of a share to increase if they have put a considerably large amount of orders at the current market price. To ensure that other investors perceive the share as interesting, market manipulators execute an equal number of buy and sell orders with different brokers. The equal amount of orders cancel each other out but result in increasing the trading volume. Investors with less knowledge take it as a sign of increased interest and invest, further contributing to higher demand. Once the share price increases, market manipulators dump their shares, which results in the crashing of the share price.

Furthermore, market manipulation also works with the market manipulators trying to lower the price of a security by placing a large number of small orders at a price lower than the security's current market price. Once other investors see numerous orders at a lower price, they perceive overall sentiment as unfavourable and think that there is something wrong with the company. As it indicates that the share price may decrease, they sell their shares to cut losses, which lowers the security's market price.

Example of Market Manipulation

In 2019, the Securities and Exchange Board of India barred 12 entities for 4 years from trading in the securities market as they were found guilty of manipulating the share price of Ram Minerals and Chemicals Ltd.

According to SEBI, the entities executed a large number of trades to match the price of the prevailing buy orders. The buy orders were placed at a price higher than the previous traded price. Therefore, the manipulated orders increased the company's share price and resulted in misleading the investors. During the period of examination from December 2013 to December 2014, SEBI realised that the share price of Ram Minerals and Chemicals Ltd rose from Rs 2.20 per share to Rs 219.55.

The probe by SEBI revealed that the 12 entities were connected and in constant discussions with each other and planned to manipulate the share price by placing the artificial orders together. Although numerous buy orders were available, the entities sold a very small quantity of shares and performed only one transaction a day.

Stock Market Manipulation Method

There are numerous ways market manipulators use market manipulation. Some of the most common ones are as follows:

  • Wash Trading: In this type of market manipulation method, entities pick a single stock to sell and repurchase repeatedly to generate increased trading activity. The repeated buying and selling increase the trading volume and attract investors by letting them think that the share price will increase. Once the investors buy the shares, the share price increases.
  • Brokers and Pledged Shares: It is common industry practice for promoters to pledge their holding to raise loans. Market manipulators influence the market to reduce the share price, resulting in decreasing the total price of pledged shares. With the shares losing their value, promoters are forced to make up for lost collateral. Since it is an indication that the lender may dumb the shares if the margin is not met, the investors start to dump shares in a panic, further lowering the share price.
  • Pump and Dump: Pump and Dump is one of the most common market manipulation methods. Manipulators buy shares in huge numbers and then spread false news to represent them as positive announcements. The shares are represented as the next best thing or multi-baggers to ensure that the uninformed investors find the shares undervalued.

    The investors invest thinking that the shares will increase in their price, which results in increasing the demand and, thus, the share price. Once the share price increases, the manipulators dump their shares in a single transaction. It crashes the share price to go to its true value, forcing investors to incur massive losses.

  • Short and Distort: In this type of market manipulation, the bears (who make profits by short selling) target a stock that has been increasing its price steadily. They take short positions in the stock to increase the share price artificially and follow it by spreading negative news about the company. This creates an unfavourable perspective for investors who dump the shares to cut their losses. It rapidly decreases the share price, allowing the short-selling manipulators to make huge profits.
  • Spoofing: This market manipulation technique occurs when the manipulators place a large number of orders in the market without any intention of buying the shares. Uninformed investors take it as a sign that a prominent trader is waiting to buy a large number of stocks which will eventually increase the share price. The investors invest in the stock and increase the volume. At this time, the manipulators pull the orders back, and the investors are forced to dump the stocks, lowering the share price to a level where the manipulators are comfortable buying.

Final Word

Stock market manipulation is illegal, and the entities are charged with civil lawsuits and bans. However, as they are difficult to detect, it is important for every investor to not fall for such market manipulation techniques. With the knowledge of what market manipulation is, you can better analyse your trades and ensure that you are not being manipulated by market manipulators. The best way is to spend time learning about the stock market factors and not base your investments on external calls.