Naked Short Selling and Other Market Manipulations
In a free and fair stock market, stockbrokers buy and sell shares of publicly listed companies, and the stock exchange tracks the demand and supply of the stock. But unfortunately, there are market manipulators who interfere with the market by creating a misleading impression of the price of a commodity for personal gain.
There must be regulations to guide any system, especially when dealing with money, otherwise, things will go berserk. For instance, in the online gambling world, players are usually advised to stick to playing in licensed and regulated platforms such as VulkanVegas EU. Otherwise, it is easy to be a victim of fraud in unlicensed online casinos. Depending on the jurisdiction, there are different gambling laws to guide operator activity and protect players so that they can safely enjoy themselves.
In the US, market manipulation is prohibited under the securities and antitrust laws where the SEC rules forbid fraud when buying and selling securities. In addition, the Securities Exchange Act prohibits unlawful manipulation of a share price. Today, we look at the most common ways used by swindlers to manipulate the market.
Naked Short Selling
In normal circumstances, traders must borrow or determine a stock is available for borrowing before selling it short, which is not the case with naked short selling. Naked shorting happens because a stock is in short supply or the cost of borrowing the stock is too high. If the short seller cannot borrow the shares and tender them to the buyer within the clearing period, the trade has “Failed to deliver” (FTD).
It is important to note that FTD may not indicate naked short selling but can result from short sales or long transactions when purchasing stocks. In 2008, it was alleged that a ‘Fail to deliver’ of about 32.8 million shares caused by naked short selling forced Lehman Brothers Holding Inc to file for bankruptcy. It was made illegal after the 2008-2009 financial crisis, but to date, it is difficult to measure how often naked shorting occurs.
Corner a Market
Markets encourage friendly competition, which allows for competitive price discovery. But then, this kind of market manipulation involves acquiring adequate shares of a particular asset, making it possible to manipulate the share price and limiting the number of market players, therefore, backing the market in a corner.
Of course, an investor will have to buy enough physical assets or amass a key economic activity to corner the market. For example, in the 1970s and early 1980, the Hunt brothers tried to hoard silver to corner the market and drive the silver price up. Unfortunately, after 10 years, their plan failed after they could not access funds to buy more silver, and the market collapsed when there were no willing silver buyers apart from the Hunt brothers.
It is a situation where stock bashers spread false information about a publicly listed company to decrease investor confidence in a bid to devalue its stock. The stock bashers create false information claiming to have insider information on the future performance of the company. Stocks of smaller companies are easier targets because it is easier to influence the market, and new investors may fall prey to their tactics.
The internet has made trading in the stock market more accessible, but unfortunately, we have also seen a rise in the number of bashers who can be found on online investing platforms. The bashers sometimes work with investment firms, and their work is to convince investors their stock is worthless, therefore driving the price down increasing the number of shares the investment firm receives.
During spoofing, traders use automated pre-programmed trading instructions that account for variables such as volume, price and time to outdo other players in the market, giving them an upper hand during trades. In addition, the traders pretend to have interest in particular shares, hence creating supply and demand for the commodity.
For example, spoofers fill in a substantial number of limit orders on the offer or bidding side of the limited order book, leading traders to believe there is pressure to buy or sell an asset. Spoofers bid or offer with the intention of cancelling the order before it is executed. Because the market is order-driven, prices may change if other investors read the one-sided pressure as a shift in the market preference of a stock.
In 2015, there was a case against Navinder Singh Sarao, commonly known as the Hounslow day-trader, who was said to have used the 188-and-289-lot spoofing method to increase the manipulate effects of his dynamic layering technique.
This is a situation where an investor buys and sells the same shares to create false market information. The trader may get involved in wash trading to trade volume for a particular stock or generate commissions for brokers. The Commodity Futures Trading Commission (CFTC) bars a broker from collecting a commission on such trades even if they claim they were unaware of the illegal dealings. In such a case, the Securities and Exchange Commission in 2014 charged Wedbush for failing to maintain exclusive control over settings that enabled high-frequency traders to engage in wash trading.
Such market manipulation practices lower public confidence and may cause hefty losses on investments, mainly by newbies who have may not be conversant with the illegal practices. Thankfully, most countries have installed measures to prevent manipulators from interfering with demand and supply for their selfish gains.