Thursday, December 6, 2012

Stock Market Manipulation...

One of the many things I learned while working in the electronic stock trading industry was just how common – and easy – stock market manipulation is.  Some forms of manipulation are illegal, and some are actually completely legal.  One of the illegal forms of manipulation is the practice of making trades solely for the purpose of raising a company's apparent market capitalization (“market cap”).

The Wall Street Journal has an excellent and detailed analysis of how this works, complete with real world examples.  This particular form of market manipulation leverages one of the odd customs of the fund management world: the determination of a fund's value by using the closing price of the stocks it holds.  The closing price is simply the price of the last trade of any given trading day.  For stocks that trade thinly (that is, not many trades during any given day), it's not hard to arrange for your trade to be the last trade of the day – all you need is the cooperation of someone who holds the stock and is willing to sell it to you for an above-market price – and for you to buy it at that price. This needn't even involve much money, as a trade of even a single share will still set the closing price.

This particular market manipulation could be eliminated quite simply, by changing the basis for fund valuation from closing price to a weighted average price.  I've seen this proposed on several occasions, but I have no idea why this hasn't happened...

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