Understanding Market Manipulation

A critic of cryptocurrency made the statement, "Why is Bitcoin so valuable when it is based on nothing." My response, "What is the US Dollar based on?" The answer is the same. Nothing. So why is the dollar, pound, Euro, Yen, and many other currencies valuable?

The answer is because everyone agrees that it is. This universal agreement is the same that gives value to gold, stocks, and every other exchange-traded asset. When enough people believe something is valuable, they drive demand.

When driven to a frenzy, demand rises beyond supply. Think about popular Christmas toys where a $15 plastic doll goes for $500 on eBay. After the excitement dies, the demand and associated price drops. The $500 toy can then be purchased in abundance for $5 from a discount bin.

The most basic market manipulation uses this strategy to drive up prices artificially. It could be a billionaire's comments, a media story, or social media strategies that drive prices up. Once everyone moves on, the price goes back down.

Pump and Dump

A more severe form of this manipulation is when an organized group works to prop up an asset just to sell soon after. It usually involves insiders buying an asset for a meager price and then convincing a large number of people that it has value. The result is a rise in price until the original investors close their position during the peak.

Once a large block of the asset crosses the market, the supply suddenly becomes higher than the demand. An action that results in everyone else holding a near-worthless asset.

Correlations

The London Interbank Offered Rate (LIBOR) is the interest rate banks use to loan money to other banks. When LIBOR changes, it impacts the price of gold due to fears of currency inflation. This correlation is the same for other assets perceived as safe havens from currency devaluation.

Correlations occur in other markets too. For example, when Bitcoin (BTC) undergoes positive movement, other coins often follow. While not manipulative in itself, this phenomenon can make assets appear better than they are.

Anticipation

According to Benoit Mandelbrot, markets move based on anticipation. A conclusion derived after a scientific study of 100-years of market prices. This expectation comes from the collective view of the majority. The problem comes from understanding how much and when the market will reflect their opinion.

This outlook is why Tesla stock drops when Elon makes a negative comment on Twitter. It also explains why Bitcoin has not broken 20,000 USD at the time of writing despite numerous devotees claiming it will. Markets react on their own time.

Sentiment

Part of crowd anticipation is sentiment—the collective opinion on the asset in question. A good measure of this is social media. In 2011, a team from Stanford University predicted stock market movements with 87% accuracy using Twitter sentiment analysis. If interested, here is the original paper.

This paper illustrates how a relatively small number of Twitter influencers could alter markets. For example, a fund taking a long position in XYZ Stock could hire top trading personalities to Tweet positive things about it. In a few days, if a significant enough number of active traders buy-in, the price moves upward.

Billionaire fund managers do a version of this each time they discuss a trade. The news reports it, social media repeats it, and public opinion changes. CEOs of public corporations do the same.

Conclusion

It is anticipation that drives price. Part of this anticipation is the sentiment of active traders. However, this sentiment can be manipulated for short-term gains. For how long and to what degree remains a mystery. At times this manipulation is unintentional while others it is blatant.



© 2021 Todd Moses

The strategies discussed are for illustrative and educational purposes and are not a recommendation, offer, or solicitation to buy or sell any currency or to adopt any investment strategy. There is no guarantee that any strategies discussed will be useful. Todd Moses is not a licensed securities dealer, broker, or US investment adviser or investment bank.