Market Manipulation 101

As Hurricane Sandy hit the US east coast, the WSJ reported that institutions found work-arounds for trading their portfolio:

Even with the U.S. stock market closed, investors found ways to trade. "You can work around it to a certain extent," said Nanette Buziak, head of equity trading at ING Investment Management. On Monday morning, "where I would have been trading in stocks, we ended up trading what we needed to in futures. We're also still trading where we need to in international markets."

This brings to mind the risks of market manipulation. Even with a relatively thin market, traders can find work-arounds to arbitrage away attempts at manipulation. Consider this New York Times story about the Romney contract on intrade.com about a week ago [emphasis added]:

For a moment it looked as if Mitt Romney’s chances of becoming the next president were up, way up.

His odds of winning the election soared around 10 a.m. Tuesday to nearly 49 percent on the betting site Intrade, up about eight percentage points from a few minutes earlier.

The numbers on Intrade, which have put the odds of President Obama’s winning on Nov. 6 at over 60 percent for the last several weeks, are closely watched by pundits and Wall Street traders because they are constantly updated based on wagers on the changing election odds. In 2008, the site’s users correctly predicted an Obama victory.

But the system is relatively thinly traded and so a few politically motivated bettors with money to burn can place strategic wagers that push around the numbers displayed on the site.

Was it an attempt at manipulation or just a naive trader pushing up the price of the Romney contract?
As I write these words, the intrade Obama contract is steady at about 63% and Romney at 37%, which are roughly the levels they were at during the summer.

If I had a few bucks to throw around and I was intent on moving the presidential election odds around in Romney's favor, here is what I would need to do in order to cover all the "work-arounds" that other traders would try. First and foremost,  I would push the price of the Obama contract down and the Romney contract up and I would need sufficient capital to maintain them at the levels I want.

Next, I would need to manipulate the prices at the state level on intrade. Perhaps push CO and VA into the leaning Republican category and move OH into either a tossup or leaning Republican state. Since those contracts are relatively thin, it shouldn't be that hard to move them and maintain prices at desired levels.

Even though trading on intrade is relatively thin, don't forget that intrade prices can be arbitraged. So don't forget to push the odds around on UK-based sports betting sites such as Ladbrokes:

...and Betfair:

Also don't forget other prediction markets like the University of Iowa's election market too!

Whew! Market manipulation is hard! That's because markets are relatively efficient, at least in a crude way.  Even in thin markets, the Invisible Hand can find work-arounds if the market manipulator isn't careful.

The moral of this story: If intrade odds move around in a dramatic fashion between now and election day, look at these secondary indicators to gauge if someone is trying to manipulate markets in order to give a false picture.



Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.