Unfair trading practices or manipulative strategies can create a false impression of market activity, distort market prices, and deceive investors. Manipulators often use artificial tactics to inflate or deflate prices and trading volume as well as to spread false or misleading information about a company’s financial status, products, or future prospects to mislead investors and make them take decisions based on inaccurate information. Unfair trading practices can take various forms. Here’s a brief overview of some unfair trading practices:
Insider Trading
Insider trading refers to illegal buying or selling of a publicly traded company’s stock by someone who has access to confidential information about the company’s finances, products, or other important developments like mergers, acquisitions, or new product launches that is not yet publicly known. Insider trading can deceive other investors who are not privy to the same knowledge. Insider trading erodes the investor’s trust and discourages people from investing as well as undermines the fairness and transparency of the financial markets.
Circular Trading
Circular trading, is a form of market manipulation where a group of traders buy and sell the same securities among themselves multiple times, often at the same or very similar prices to create the impression of significant trading activity. This can mislead other investors into thinking there is genuine interest in the security. The goal of circular trading is to artificially inflate or deflate the price of a security.
Wash Trading
Wash trading is a form of market manipulation in which a trader or group of traders simultaneously buy and sell the same financial instruments (stocks, bonds, or options). The goal is to create the illusion of genuine trading activity without actually taking any market risk or changing the market price. Wash trading can artificially inflate trading volume to mislead other investors and affect their trading decisions.
Front Running
Front running is the unethical practice of a broker or trader with advance knowledge of a future transaction that will affect the price of the asset. This order could be from a client or even their own firm. This gives the front-runner an unfair advantage over other investors who are unaware of the upcoming large order. Front running is illegal because it creates an uneven playing field where those with privileged information can profit at the expense of others.
Spoofing
Spoofing is a type of market manipulation where traders place orders with the intent to cancel them before they are executed, creating a false impression of supply or demand in the market. Before the large order is executed, the trader cancels it — sometimes within milliseconds of placing the order. By placing these large orders, the trader creates a false impression of demand or supply. The goal of spoofing is to profit from the resulting price movement. Spoofing can distort market prices and deceive other market participants.
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Pump and Dump
Pump and dump is a form of securities fraud in which the fraudsters, or “pumpers,” artificially inflate the price of a stock or other security by spreading misleading information. The net result is that the price of the stock is artificially inflated when more people rush to buy the stock based on the false information. Once the stock price has been pumped up, the fraudsters sell off their shares at a profit before the hype ends. This sudden selling pressure causes the stock price to plummet, leaving other investors with losses.
Churning
Each trade results in a commission for the broker, so when more trades are executed, the broker earns more commissions. There are instances where brokers use aggressive or deceptive sales techniques to pressure investors into buying financial products or securities that may not be suitable for them or execute trades without the customer’s permission, to generate more commission for themselves. Churning is a deceptive practice in the financial industry where a broker or financial advisor engages in excessive or unnecessary buying and selling of securities to generate commissions often ignoring the customer’s investment goals, thus causing financial harm to the customer. Churning is considered unethical and illegal because it arranges the broker’s financial gain over and above the best interests of the client.
Bucketing
Bucketing refers to an illegal practice where a broker or dealer takes the opposite side of a customer’s order without actually executing the trade on an exchange or in the market. Instead, the broker or dealer matches the customer’s order internally, keeping the trade “in-house” and profiting from the spread or mark-up on the transaction. Here’s how it works: A customer places an order to buy or sell a security through their broker or dealer. Instead of executing the trade in the market or on an exchange, the broker or dealer takes the opposite side of the customer’s trade themselves. The broker or dealer profits from the spread between the price at which they execute the trade with the customer and the price at which they could have executed the trade in the market. Bucketing can result in conflict of interest because brokers and dealers are supposed to execute customer orders at the best available price in the market, rather than profiting from the customer’s trades themselves.
Abusive Short Selling
Abusive short selling is the illegal or unethical practice of short selling a security to manipulate its price. Short selling involves selling a security that the seller does not own, with the expectation of buying it back at a lower price in the future to make a profit. Short sellers may spread false or misleading information about a company to drive down its stock price, to profit from their short positions. The term naked short selling is used to describe the practice of selling borrowed shares that haven’t actually been secured. In essence, the seller is promising to deliver shares they don’t possess, hoping to buy them back later at a lower price. This can create a false impression of high supply and drive the price down. Excessive short selling can damage a company’s reputation and make it difficult for them to raise capital as well as harm employees and shareholders.
Painting the Tape
Painting the tape is an illegal market manipulation activity where traders or brokers buy or sell a security among themselves at a predetermined price and volume to influence other investors and attract more buyers. The ultimate aim is to create the false impression of active trading and drive up the price.
High-Frequency Trading (HFT)
High-frequency trading (HFT) is a type of algorithmic trading using sophisticated computer programs and high-powered technology to execute trades at incredibly high speeds, often in milliseconds or even microseconds. The highly complex algorithms are designed to exploit tiny price discrepancies and capitalize on short-term market movements. Traders using HFT place a massive number of orders, but most are cancelled quickly. The goal is to profit from small gains on a large volume of trades rather than holding positions for an extended period. Critics argue that HFT strategies like spoofing (placing fake orders) can create an unfair advantage and manipulate prices. HFT also puts smaller investors at a disadvantage compared to large institutions with superior resources and high-tech infrastructure.
