6 Common, Difficult to Detect Manipulative Trading Practices

Manipulative trading practices comprise a much larger number of activities than various insider-trading schemes. In fact, most manipulative trades are far more discreet – and harder for broker dealers to detect. Given the high frequency of transactions and volume that most brokerages handle, manually finding an illicit trade is incredibly difficult.

Yet although these practices are harder to root out, sell-side firms still have a responsibility to oversee all trading activity, and catch even the most conspicuous red flags.

The SEC and FINRA are always looking for these common and hard-to-find manipulative trading practices:

1. Order Spoofing: This is an umbrella term for different tactics where traders submit orders without the intention of carrying them out. For example, a trader who owns a particular stock places an anonymous buy order for a large number of shares of the stock, then quickly cancels it. The price of the stock immediately rises, causing investors to believe there is high demand and drawing them into buying the stock – allowing the trader to sell his shares at a higher price.

2. Layering: Another form of order spoofing that involves a trader placing one real, “bona fide” order, followed by a series of fake, non-bona fide orders to skew the perception of the supply and demand of the stock as a way to induce others to buy or sell at the new price. Once the value has been manipulated, the non-bona fide orders are then cancelled. This technique may also involve large amounts of “wash trades,” that have no economic effect, to achieve the appearance of market depth, allowing traders to take advantage of the market’s reaction to the layering of orders.

3. Painting the Tape: A scheme where a group of traders buy and sell a specific stock amongst themselves to create the appearance of high trading volume and significant investor interest, which skews the stock’s price. This lures unsuspecting investors to buy the stock, resulting in a higher closing price for the stock, so the traders make a profit.

4. Odd Lots: This refers to an order amount for a stock that is less than the normal trading unit, typically any order fewer than 100 shares. Rather than institutional traders, small personal investors tend to place odd-lot orders. Many exchanges mandate that specialist firms handle odd-lots to even the playing field between small and large investors, requiring small trades to receive the same stock price as larger transactions. In recent years, some firms have been charged with breaking up large block orders into odd lots, forcing specialists to trade them at a loss.

5. Wash Sales: This involves selling a security at a loss, then repurchasing the same or similar securities before or after the sale. Committing multiple wash sales can manipulate the market by increasing a security’s activity and inflating the price. Investors used to carry out wash sales so they could claim a capital loss as a tax deduction. The effectiveness of this strategy has been greatly diminished by an IRS-implemented ruling that a taxpayer can’t recognize a loss on an investment if that investment was purchased within 30 days of sale.

6. “Marking the Close” or “Portfolio Pumping”: Influencing a stock’s closing price by submitting purchase or sale orders right before the end of market hours. Typically, money managers will submit high bids for shares of a stock they already own in order to boost its value. They wait until the end of the quarter when they report results, making their funds look more appealing to potential investors. In doing so, they can attract new money and earn higher fees.

The importance of monitoring for manipulative trading practices has increased as regulators like the SEC and FINRA crack down on broker-dealer compliance. Though traders who carry out these schemes attempt to mask their deceptive practices, broker-dealers and sell-side firms should increase their efforts to look out for fraudulent trading activity at all times.