How does Price of an Asset Gets Manipulated
There is more to this (asset price) than meets the eye
For the un-initiated, investing and trading assets (securities) is a wild wild west. Market participants with large amount of resources (money and technology) might gain an edge by deploying unfair tactics to befool others. In today’s blog post, I will discuss how the price of an asset gets manipulated and I will throw a real example close to the end.
Let’s begin by telling you a story
Suppose Alex wants to sell a car. That car is the latest Toyota Kijang Innova Zenix below
Looks cool? Of course it does look cool. Look at that handsome grill.
So Alex puts up a billboard and say that
Hey guys! This Kijang Innova is selling for Rp 500.000.000,-. Hurry buy now!
But here’s the catch. Alex does not have the car.
Wait what? How can Alex sell the car without having it? Answer is: no body knows Alex does not have the car
So Bob looks at Alex’s billboard, calls him up and say
Bob: Hey Alex, I want to buy that nice Kijang Innova.
Alex: Hey Bob, for sure! I will get them delivered to your house by next week.
Now here’s the fun part. Alex then post 1000x billboards to sell the car at Rp 400.000.000,-. This billboard is literally everywhere and people can see.
But that billboard is not meant to sell the car at that price for real. It is only to give the impression that the car is sold at Rp 400.000.000,-
Until Carol comes along and she really has an Innova Zenix and she really wants to sell her car. At what price do you think Carol will sell her car at after seeing that billboard?
That’s right! Rp 400.000.000,-
So Carol sells the car and Alex phones Carol up to buy the car at Rp 400.000.000,-. The car gets delivered to Alex and then Alex delivers the car to Bob who has agreed to buy the car at Rp 500.000.000,-.
For the cost of posting billboards and not owning any car, Alex pockets the difference of Rp 100.000.000,-, neat. (maybe posting billboards is more expensive, but we’ll do the accounting and finance later).
What story have I just read?
The story that you have just read is a simplified explanation of spoofing. It is illegal in most jurisdictions by the way. So do not try this at home.
It means that you can practically change the price of an asset that is tradable by creating orders that you do not intend to execute.
If you want to give the impression that the price of a good is low, you can create a fake sell order at a lower price. People will then think that there is a lot of supply pressure for the asset and they will naturally sell the asset at a lower price.
Otherwise, if you want to give the impression that the price of a good is high, you can create a fake buy order at a high price. Then people will think that there is a lot of demand pressure for the asset and they will naturally buy the asset at a higher price.
If you want to learn more, you could read its dedicated wikipedia page.
Examples of Spoofing
An example of a giant multi national entity being fined close to $1 billion for manipulating the market can be found in this Reuters article.
There are definitely other cases of spoofing which is not documented publicly. I suspect there should be a lot of this in cryptocurrencies too because the industry is not super regulated in many jurisdictions, open 24/7, still relatively small (only about $1 Trillion in market cap as of 2023), and allows for trading bots to operate. Investopedia even has an article on this.
Closing Remarks - How to protect myself?
Always have an investment strategy and then stick to it. Price volatility always gets to everybody’s emotions because we are humans not robots (especially when they go against your favour).
To me, staying patient and rational usually works out at least for the long term.