How to Legally Manipulate Stock Prices

Institutional Investors Can Move Stock Prices to Their Advantage

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Manipulating stock prices can happen quite easily, and it takes place more often than you might think. Achieving it in a perfectly legal way is not necessarily difficult, depending on how much trading power an entity has.

Individual stock investors don't have ready access to these types of market-manipulating techniques and, consequently, often end up being on the losing end of these schemes. In this situation, a little knowledge can go a very long way.

The Basic Process

Many ways exist to accomplish the same result of driving market prices in a certain direction. This technique might seem pretty basic, but it works and it's relatively simple to accomplish. Here's what takes place. Suppose a big institutional investor in hedge funds, mutual funds, and insurance companies zeroes in on a stock that it owns and begins selling it off.

As the large investor dumps the stock onto the market, the price will naturally begin to take a nosedive. Other investors might start to panic, and then begin to unload the stock as well. As a result, the stock's popularity, and of course price, continues to fall.

At some point, the institutional investor decides that it's time to jump back into the market and it begins an aggressive buying program to acquire new shares of a given stock. Soon other investors notice that the stock's price has begun to rise again, and they also begin to buy up the stock so they can ride the price up and make a profit. This demand continues to push the price up higher. The cycle might begin again when the price hits a sufficiently high price, and it often does.

The Slingshot Effect

Large institutional investors, because of their huge purchasing power, have the ability to drive prices down by selling off large positions in a given stock, and then buying back into the stock at a significantly lower price. Then, these large investors ride that price up as others join the rally, and then pocket a hefty profit as a result.

This is called the slingshot effect and it was well described in a much-quoted article by Jason Schwarz back in 2009. In the article, he referred specifically to Apple stock. Is this strategy legal? Yes, it is. Can you ride the wave, too? Maybe, but more importantly, you can learn a valuable lesson from it.

What's in It for an Individual Investor?

This same scenario happens with many different stocks, and there's a lesson here for individual investors.

The average investor must learn never to count on short-term gains in a stock because those could evaporate very quickly for what appears to be no apparent reason. You can count on there being an underlying reason, however. You just might not know what that reason is at the time.

Consider your transaction costs before making trading decisions, but if you have a good profit in a stock, you might want to consider taking some off the table by selling part of your holdings if you have a suspicion that a large, institutional trader is manipulating the stock.

This way, if the stock is, in fact, being manipulated or something else happens that causes the price to fall, you've engaged a defensive strategy and have at least captured part of your gains and avoided some losses.

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.