Market Makers and Stock Manipulation
As an investor, you need to beware of what roles market makers play. You must know how they go about stock and market manipulation for you to make sound investment decisions.
Market makers play a major role in the stock market. Most are brokerage companies acting on behalf of investors and large financial institutions.
Normally, their bids and selling prices are based on the public quoted prices, and they update stock prices regularly to reflect the current demand and supply which, is always changing.
Market makers can easily influence the demand and supply of securities available in the market to their advantage through various tactics that we shall discuss.
Market Makers: What are they?
As the term suggests, market makers create a market specifically for financial securities. They present a ready market to buy and sell securities, and in so doing, market makers make the trade for securities much easier and faster for investors.
Without market makers, transactions in the stock market would be minimal and slow due to the lack of an immediate and readily available buyer or seller.
Market makers profit mostly from the bid-ask spread, which is usually a small spread. Their trick is to get the most demand on securities and increase sales volume.
Higher volume trading on the stocks will lead to larger profits off the minimal bis-ask spread.
The function of a 'Market Maker'
Market makers provide a ready market for the sale and purchase of stock. If you are looking to purchase 200 shares of Microsoft, it is unlikely that you will find a seller with the same offer, and that is where market makers come into play.
Market makers will bid or sell stocks from their inventory, thus availing investors of a ready market.
Market makers also help promote the liquidity and depth of the market. They play a major role in controlling the demand and supply of securities available in the market.
They influence the price of a security by evaluating its supply and demand curve and regulating its price accordingly. In cases where a financial asset is overvalued, market makers can reduce its price thus, resulting in increased demand and more transactions on said security, and vice versa applies.
Market makers are also responsible for making margin calls to investors for additional funds when the value of their margin account falls below the market maker’s required amount.
In such instances, as an investor, you will need to decide whether to sell off some of the account assets or deposit more funds into the account.
How Market Makers Manipulate Stocks
As mentioned earlier, market makers can tweak the stock market demand and supply to their advantage. They do so by artificially inflating or deflating the price of a security.
There are several techniques that market makers use to influence a stock price. Let us debunk some of the most common market manipulation tactics used by market makers.
Market makers can create a false sense of demand for a particular security to lure investors. For instance, a market maker can increase the asking price for a given stock, and when investors see this, they might interpret it to mean that the demand for that particular security is high.
This creation of false demand influences investors to purchase the security in bulk, hoping for a big return on investment. However, this does not happen because it was a stock manipulation scheme meant to increase the number of transactions on the security.
It is advisable that before making huge investment decisions based on stock price changes, verify the authenticity of the change. You can do so by studying the stock markets to help you in understanding price.
Pump and dump
Market makers use this technique to bullishly manipulate investors into buying stocks of a company by inflating its stock prices. This manipulation is done over numerous promotional email proclamations about said company to attract buyers.
The pump happens when high volume trading occurs, and buyers invest by purchasing more company stocks.
Once market makers attain their target, they cash out and jump ship. Promotional investors also sell off their shares, resulting in company stock prices plunging, the dump. A regular investor then finds themselves in a sticky situation with overvalued and worthless stocks.
A way of circumventing the market makers is to avoid investing in spiking stocks especially, those of unestablished companies.
The ticket switch
Before executing an order, a market maker must fill out a ticket and present it to the clerk at the dealing desk. The procedure takes time, and during the process, the market continues to change.
By the time the market maker fills his ticket and hands it to the clerk, the price of a financial asset can move from $20 to $20.5. Sometimes, market makers take advantage of this time delay to cash out on the profits into their accounts.
In case the price of the security diminishes during the period, market makers can change the bank account information and cash out on it by using an investors trade-in account as a cover.
Therefore, when executing an order, maintain your position over the counter up until the end of the transaction. Ensure you verify that the clerk fills your order and correspondence done immediately.
What is spoofing and how it works
Spoofing usually affects short term securities. The market makers typically post large amounts of a bid or ask on the dealing desk without an intention of fulfilling them.
The rise in the bid or asks misleads investors into thinking that there is traffic on a given stock. This false sense of traffic influences investors to either buy or sell the securities. By so doing, high volume transactions occur and, the spoofer profits from this spike inactivity.
You can protect yourself from such manipulative tactics by really studying the market and stock charts. Through studying the trends, it is easier to understand better who the key players are. You will also be able to tell when market makers are manipulating the market for personal gain.
Manipulating cheap stocks
A common form of stock manipulation is through traders manipulating cheap stock, also referred to as penny stock. Most of these cheap stocks are worth less than $1 and, many inexperienced investors fall prey to market makers manipulating stocks and lose money.
Cheap stocks are easier to manipulate because of their low-price value and their plentifulness in the market. Market makers can push the shares up by another $1 thereby, doubling their money.
Penny stocks are displayed on the market alongside other securities. Unseasoned investors may easily choose to invest in them because of their affordability and presumed low risk.
It is important that before investing in cheap stock, ensure that you do your due diligence. Make sure you do a background check on the companies to avoid investing in nearly bankrupt securities, no matter how cheap.
What You need to know
The world of market and stock exchange is highly volatile, and most market makers are out to take advantage of this volatility. The Securities and Exchange Commission and other regulatory bodies are working hard on investigating and prosecuting market manipulation cases.
If you are looking to invest your financial assets in the stock market, you must acquaint yourself with the market beforehand.
Study the market to learn a few tips and tricks on how market makers manipulate stocks so that you do not fall prey to their get rich fast schemes. You can find more information on the stock market and market makers on our website.
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