36

Let's say company FOO is trying to increase their $20 stock price.

They agree to sell a share for $100. Of course, nobody buys.
Now their buddy buys the share for $100. And maybe sells it back for the same price.
Suddenly the stock price, which is defined to be the last price seen, has increased 5x.

What prevents this from happening?

  • 7
    I'm not sure on the exact rules and mechanics, but this is probably considered market manipulation and would be illegal. – Michael Hartmann Jan 30 '18 at 19:40
  • 34
    "What prevents this from happening?" lots of people willing to sell the stock for less than $100. – D Stanley Jan 30 '18 at 19:46
  • 16
    Say FOO does increase from $20 to $100 due to only one buyer and one seller - so what? How does that benefit the company or a shareholder? A company does not profit from its stock price, and a shareholder would need another buyer in order to sell their stock for $100. – D Stanley Jan 30 '18 at 19:48
  • 1
    @DStanley: Oh right, so this is where having a centralized exchange makes a difference right? You can't buy for a higher price than the minimum one? If so you should post that as an answer! – Mehrdad Jan 30 '18 at 19:49
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    Lots of people are doing exactly this, and similar market-manipulation techniques, with various crypto-currencies – BlueRaja - Danny Pflughoeft Jan 31 '18 at 0:16
74

In a more liquid stock, like say Apple or Google, this is pretty difficult to achieve. That is because there are so many more actors trading the stock than simply Manipulator A and B. Naturally, more transactions and volume leads to a more transparent "equilibrium" price.

The scenario you posited is very possible in less liquid stocks. Manipulators have done exactly what you are asking. Mainly the reason people don't do this is because it's illegal. It is both stock manipulation and fraud, which are felonies.

One distinction worth pointing out though is the difference between deliberate manipulation and simply irrational investing. If actors A and B genuinely believe this stock is undervalued and that the $100 per share valuation is justified, then transacting above market price is not illegal. It is when actors A and B willingly manipulate the price of the security based on nothing other than financial gain that this becomes illegal.

Edit: Tangentially related, but a lot of traders just went to prison for a similar thing called "spoofing". Basically the traders would enter Buy orders way above market price like you are suggesting, which would trigger other algorithms (the legal ones) to transact at a price above current market value, bumping up the share price. The original algo would immediately cancel the 'fake' order and the traders would turn around and short the stock. Source: https://www.justice.gov/opa/pr/eight-individuals-charged-deceptive-trading-practices-executed-us-commodities-markets

Edit 2: removed paywall FT link and provided citation from DoJ

  • 4
    @Mehrdad It could fly under the radar, but with that comes the tradeoff of leverage and overall your potential gain from manipulation. Say you wanted to only transact a few cents above market price, you would need to make A LOT of transactions for any real gain. The SEC would catch on to the massive uptick in liquidity and probably start sniffing around. – HK47 Jan 30 '18 at 19:53
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    There's a bid price and an asked price along with a bid volume and an ask volume. At this very moment, for AAPL it's $166.40x$166.43 with a size of 4x6. That means that a buyer(s) is bidding to buy 400 shares at $166.40 and a seller(s) is offering 600 shares at $166.43. If you place a buyer order for 100 shares at $166.43 or $176.43, you will get 100 shares at $166.43. If these quotes were on the OTC and two brokers effected a trade at $100 (which is illegal) as soon that trade printed, the quote would return to $166.40x$166.43 with a size of 4x6 (NBBO). – Bob Baerker Jan 30 '18 at 19:58
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    continued... In very illiquid stocks, it's possible to paint the tape at the end of the day (buy 100 shares at the ask for an issue with a wide B/A) but that lasts until the next trade at reality's prices. – Bob Baerker Jan 30 '18 at 19:59
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    @Aaron US financial securities are tightly regulated. If a security is traded on a public market then it may only be traded on a public market; it's illegal for two brokers to trade securities off of the market. Public exchanges must allocate your shares to the highest bidder even if you say you want to sell at a massive discount. (Likewise, if you say you want to buy at a massive surcharge, you're still matched against the lowest seller.) – dg99 Jan 30 '18 at 23:54
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    @Aaron: Read the OP's question again FOO stock is $20 and they are attempting to "Paint the Tape" at $100. The only way to do that is for two brokers to arrange a trade at $100 and that is illegal. Once you get that, read my previous reply about AAPL as well as dg99's reply. Our comments explain that regardless of how generous you feel, orders are filled at NBBO. That's how the financial markets work, regardless of your charitableness. – Bob Baerker Jan 31 '18 at 0:07
9

For publicly traded shares, the exchange is what prevents this from happening. At any given time for any reasonably liquid stock there will be a list of buyers with bids to buy a number of shares at a given price and a list of sellers with offers to sell their stocks at a given price.

If you stop the clock here, you will observe that no shares are trading hands and there are a large number of shares sitting out on offer to either buy or sell at a range of prices. It will always be the case at any given time that the highest bid price to buy any of these shares will be lower than the lowest offer price - otherwise a transaction would be taking place and the share price would move.

So the last traded share was done at $20/share and the market then might look something like this

Offers to sell

  • ... etc ^^^
  • 5000 shares @ $22.00
  • 4400 shares @ $21.40
  • 3700 shares @ $21.15
  • 4200 shares @ $20.75
  • 1200 shares @ $20.17

STOCK TICKER PRICE $20.00

Bids to buy

  • 1320 shares @ $19.70
  • 3100 shares @ $19.00
  • 5700 shares @ $18.77
  • 6000 shares @ $18.12
  • ... etc vvv

So when your sly friend goes to the exchange to offer to sell his share for $100 he simply goes into the offers list way up the chain behind everyone else who is willing to sell their shares for a lower price.

When a buyer goes to the exchange to buy a share they can't choose which they will buy - they can choose to either post a bid at a price of their selection and wait for a seller to come along willing to sell at that price, OR, they buy at the market price.

In this case, let's take our spread of bids and offers above as example, and let's say our buyer enters the market willing to buy 7000 shares at market prices. The exchange will negotiate the transaction from the available share pool as:

  1. 1200 shares @ $20.17
  2. 4200 shares @ $20.75
  3. And the remaining 1600 shares from the available 3700 @ $21.15

After this transaction the exchange will list the stock price as the last transaction price - this buyer, in buying these shares, will have moved the stock price up to $21.25.

If no other buyers or sellers act during this time the bid-ask spread will have increased from $0.47 to $1.45 and other buyers and sellers may adjust their positions in reaction to this.

This is the whole point of the market - a single individual with a single transaction cannot materially affect the price of a stock without engaging in such a significant purchase or sale of stock that they consume all of the outstanding bids and/or offers between the current share price and their "target" price. If you want to move a stock from $20 to $100 you have to buy a LOT of shares. Furthermore, you can't move a stock price UP by selling shares at market prices and you can't move it DOWN by buying shares at market prices.

0

Honestly, most of the time Market Makers will widen the spread to change investor sentiment and this usually will be enough to slow it down and correct itself.

0

As well as the other answers, it seems worth pointing out that there’s generally no point to doing this. Companies want a high share price for the benefit of their shareholders, so that they will get more money when they sell their shares. A spoofed price at which no real transactions can occur doesn’t achieve this.

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