How to Spot (and Avoid) Market Manipulation

Thu, May 9, 2013 - 12:00am

We often hear investors complain of financial markets (and the gold market in particular) being “rigged” or manipulated. The sad yet somewhat humorous tale of Henry Gribbohm recently brought this accusation to life. The 30-year-old Gribbohm infamously lost his life savings of $2,600 on a carnival game in an attempt at winning an Xbox Kinect valued at $100. For his efforts, he walked away with a giant stuffed banana sans his $2,600 life savings.

Gribbohm’s tale is instructive if only because it reveals a common psychological pitfall that has plagued all of us at one time or another, viz. the desire the “win back what I lost” from the market. According to news reports, Gribbohm attempted to win a ball-toss game at a traveling carnival but quickly lost $300. He then returned home to get $2,300 more in hopes of winning back the lost $300 and –hopefully- the prize Xbox. After losing everything he accused the carnival of rigging the game (sound familiar)? (The game owner actually did end up refunding $600 of his $2,600).

Had Gribbohm been thinking clearly he would have cut his losses after his initial loss. Investors who have “played the game” long enough know from experience to do this; it’s a simple money management tool that keeps you in the game and prevents you from losing all your capital. More importantly, it prevents you from allowing your emotions to get the best of you. Paraphrasing Jesse Livermore’s famous maxim, “A trading position that goes against you from the start is likely to be a losing proposition, so you should get out immediately.”

Along these lines, W.D. Gann taught that a stock or commodity that repeatedly stops you out with a loss should be avoided altogether since there could be a psychological reason for the constant losses. Gann believed it’s better to stick to trading vehicles in which you’ve shown you can profit from.

Gribbohm’s explanation for his stubborn refusal to cut his losses was revealing: “You just get caught up in the whole, ‘I’ve got to win my money back [thing].”

The above statement perfectly summarizes a truism of investor psychology which has led to countless losses for the average market participant. The way to overcome this all-too-human failure is to steel yourself beforehand with the mindset of cutting your losses the minute the trading position goes against you by a certain percentage. The use of a judiciously placed conservative stop-loss is paramount, and stops should always be employed in every trading or investment position.

Traders/investors should also consider such factors as relative volatility before initiating a new position, especially with the advent of High Frequency Trading (HFT), which if prevalent in a particular asset can increase your chances of being stopped out with a loss. This is one of the biggest tip-offs of a manipulated market. If the asset you’re watching is trading erratically or tracing out a pattern which can’t be easily classified by conventional chart pattern theory, it’s best to avoid it. Instead, trade only in assets which display “clean” and tight looking consolidation and/or continuation patterns. Better safe than sorry.

Always compare the recent and historical trading pattern of the asset you’re interested in to a broad market benchmark such as the S&P 500 or the CRB Index (depending on whether it’s a stock or commodity). It’s also imperative that the stock or commodity you choose to trade should have ample liquidity on a daily basis which makes it easier to enter or exit the trade. Lightly traded stocks and commodities are the ones most liable to manipulation by vested interests.

Manipulation is an unfortunate fact of the financial market. Stocks and commodities have always been subject to manipulation, whether by individuals, pools, central banks or even governments. If you are unable to come to terms with this reality then it’s best to avoid participating in the market altogether. But if you’re able to come to grips with this then there is money to be made once you’re able to spot the tell-tale signs of manipulation, a skill which becomes better with experience.

A “Wall of Liquidity”

Some believe that the Federal Reserve’s aggressive monetary policy known as QE3 is a form of manipulation. More specifically, it’s a form of subsidy for stock prices. For the first time in years, the Fed no longer stands alone in its aggressive monetary stimulus policy.

Bert Dohmen underscored this point in a recent issue of The Wellington Letter. He writes, “If you buy stocks now, you have the Federal Reserve, the European Central Bank (ECB), the Bank of Japan, and China’s central bank on your side. They are basically providing an insurance that the markets will not have a big decline. That’s a very good guarantee…until eventually it doesn’t work anymore. But for now, it’s the best guarantee investors could ever hope for….”

Mr. Dohmen makes an excellent point. He further points out that the Bank of Japan’s intention to buy around billion of its own bonds per month will mean “the globe is now seeing perhaps 0 billion of fresh money created each month to swamp the financial markets.” He calls this almost trillion-a-year subsidy a “Wall of Liquidity.”

Dohmen also pointed out that the ECB recently cut interest rates to 0.5%, the lowest ever for Europe. China meanwhile is starting to address the financial problems of its banks. “As Europe and China struggle with recessions,” writes Dohmen, “or at least weakening economies, their central banks will only become more aggressive.”

I agree with Mr. Dohmen that the coordinated central bank stimulus is something you don’t want to fight against as an investor. As long as the old maxim, “Don’t fight the Fed” still holds true then we certainly don’t want to fight the Fed…and the ECB and the BOJ, etc. The bottom line is that the Fed has been giving investors a veritable free ride since 2009 and that ride should continue in the coming months with all the additional liquidity being pumped into the global financial system.

Momentum Strategies Report

The stock market recovery is nearly four years old, and investors wonder if it will continue. While many experts have made forecasts for the coming year, few have been as impressive as the Kress cycles in projecting the market’s year-ahead performance since the recovery began.

Each year I publish a forecast for the coming year based on a series of historical rhythms known within Kress cycle theory. Last year’s forecast was remarkably accurate in predicting the pivotal market turns, including the June 1 bottom in the S&P.

Here’s a sampling from last year’s forecast:

“The first five months of 2012 will likely be characterized by greater than average volatility....This will create a level of choppiness to coincide, if not exacerbate, the market’s underlying predisposition to volatility owing to the euro zone debt crisis…the May-June 2006 stock market slide could be repeated in May-June 2012. Our short-term trading discipline should allow us to navigate this volatility and there should be at least two worthwhile trading opportunities between [January] and the scheduled major weekly cycle around the start of June 2012. From there, the stock market should experience what amounts to the final bull market leg of the current 120-year cycle, which is scheduled to bottom in October 2014.

“Keeping in mind that like snowflakes, no two markets are exactly alike, the Kress cycle echo analysis for 2012 tells us to expect a final upswing for stocks in the second half of the year with the first half of 2012 likely to be more favorably to the bears, especially if events in Europe are allowed to get out of hand.”

This is your opportunity to find out what the Kress cycles are telling us to expect for 2013. Subscribe to the Momentum Strategies Report now and receive as my compliments to you the 2013 Forecast issue.

In addition to that you’ll also receive the MSR newsletter emailed to you each Monday, Wednesday and Friday. MSR provides reliable forecasts and analysis of U.S. and global markets based on internal momentum, cyclical and technical factors. Low-risk stock and ETF recommendations are also made based on my proprietary system of selection. Specific entry and exit instructions are also given for each recommendation.

[For the complete 2013 Kress cycle forecast for the U.S. stock market and the latest newsletters, subscribe to the Momentum Strategies Report at the link below.]

About the Author

Market Analyst
clif [at] clifdroke [dot] com ()