Real-time Surveillance of Markets

Several markets use real-time surveillance to detect market malpractices and give quick remedies. The market malpractices that can be detected by real-time monitoring are:

• Front running: This is also known as forward trading. It is a situation where a trader buys before the anticipated sales. Front running is illegal when the front runner acquires information inappropriately. The front runners take the liquidity that the front-run traders would have taken. This increases the transaction costs for front-run traders.
• Market manipulation: Market manipulators are traders who compel others to venture into trades that cannot add value to them. Market manipulation, therefore, includes the use of tactics whose intentions are to produce misleading market prices.

Examples of Market Manipulation

• Trading for market impact: This occurs when a market manipulator is ready to incur expenses to change the price of an asset and sway how other traders perceive the business.
• Rumormongering: This involves the propagation of malicious information about a particular trader to alter investors’ value assessment.
• Wash trading: This involves the use of trade arrangements designed to lure investors into believing that a market is more liquid; thus, increasing investors’ confidence levels. Manipulators can also report trades that did not take place.
• Spoofing: This involves the exposure of standing limit orders to give an impression to other traders that the market is liquid when it is, indeed, illiquid. This practice is risky because the spoofing orders might execute before the intended orders.

Market Manipulation Strategies

• Bluffing: This is the act of deceiving people to think that you are going to do something when you have no intention of doing it. In market manipulation, it entails the submission of orders to change other traders’ perceptions. Bluffers engage in activities like rumormongering and wash trading. Therefore, financial analysts must be independent in their analysis to avoid bluffing.
• Gunning the market: This strategy is used by market manipulators to force traders to take disadvantageous trades. A manipulator guns a market by selling quickly to push prices down, then purchasing at lower prices, thus making a profit.
• Squeezing and cornering: Under this strategy, the manipulator has control over resources required to settle trading contracts. The manipulator then unexpectedly withdraws the funds from the market, causing traders to default on their contracts. The manipulator ends up assuming ownership of the defaulted contracts. In this form of manipulation, the manipulator gains by providing support at higher prices. Manipulators buy many futures contracts, which they later sell at higher rates when the contract is almost expiring.

Question

An investor buys and sells the same stock over and over in quick succession to increase its volume and make it attractive to potential investors, who will think that the activity is worth their investment. Which of the following market manipulation exercises best describes this abusive trading strategy?

1. Spoofing.
2. Wash trading.
3. Rumormongering.

Solution

The correct answer is A.

Spoofing is the exposure of standing limit orders to give a good impression to other traders who may think that a business is viable when it is not.

B is incorrect. Wash trading involves the use of trade arrangements designed to lure investors to believe that a market is more liquid; thus, increasing an investors’ confidence level. Manipulators do this by reporting trades that did not take place.

C is incorrect. Rumormongering involves the propagation of malicious information about a particular trader to alter investors’ value assessment.

Portfolio Construction: Learning Module 6: Trading Costs and Electronic Markets; Los 6(j): Describes abusive trading practices that real-time surveillance of markets may detect