Market Manipulation

Remember how I said markets are like the jungle?

Well there are plenty of predators here too. They are highly evolved, damn good at what they do, and if you don’t know who they are and how they like to hunt… it’s easy to end up being their dinner.

Now, you won’t need to worry about these predators much if you’re buying quality projects for the long term, so don’t worry about needing to constantly be on guard here. However, I’ve made this a fairly detailed section for a reason.

If you don’t know how these mechanisms work, you’ll always be anxious when markets move.

However, if you see the game for what it is, you are way less likely to freak out, because you’ll see that while in the long term, reality wins out… in the short and medium term, it’s all just a big show designed to scare you and separate you from your money. 🙂

So, since David Attenborough hasn’t done a series on these predators yet, let’s dig into things on our own. Today we’re going to cover the two most significant groups of predators that will impact your investing life, Market Makers & Institutional Investors.

**We’re focusing our attention here on how these affect crypto markets, but it’s the same basic idea for the Stock market or any other market where these kind of entities are present.

Market Makers

Let’s begin with the Market Makers. We’ll call them the vipers of the jungle, because they hide in plain sight, most people don’t even notice them, and often lure in their prey with clever little traps.

So, what is a Market Maker anyway?

Who do you picture as being on the other end of your transaction whenever you buy or sell a stock or crypto on an exchange? Most people either don’t think about it, or they picture another person on the other end, like if you were selling your house for example. I.E. Someone has to be willing to buy your house for you to sell it.

The issue is… that isn’t how modern financial markets work, at all. Do you think when everyone panic-sells during a crash, that there are an equal number of people buying on the other end? No chance. How about when prices are going up like crazy, how many people want to sell something that is skyrocketing in value? Hardly anyone.

So how is it that you can essentially always buy or sell your holdings anytime, no matter what the market is doing?

Simple. A Market Maker working for the exchange is on the other end of your transaction. That means, when you are buying, they are selling to you, and when you are selling, they are buying from you. This is the same dynamic with whatever stock brokerage you use. 

So, if a Market Maker is selling you Bitcoin while it’s skyrocketing in price, or buying some worthless memecoin from you while its price crashes through the floor… are they the suckers here, or some benevolent entity just helping you out? 

Not even close. While they are the ones on the other end of the transaction, and they are providing a valuable service to help people like you and me to buy crypto assets… they are also businesses, and they control massive amounts of capital for a reason... They’re smart, and this is their game. 

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So, let’s summarize exactly how this works. The people who actually manage all the exchange’s buying & selling and make sure your orders get filled are the Market Makers working for the exchanges. In the modern world, these are essentially just people behind the scenes who manage the buy and sell algorithms that determine the market prices on the exchange. They’re either working directly for the exchange as an employee, or for a separate entity providing liquidity (meaning funds to buy and sell) on behalf of the exchange. 

But either way, it’s the same basic idea from your perspective -- and you can simplify this in your own mind by just thinking of it as the exchange itself being on the other end of your transaction. 

The name Market Maker comes from what they are actually doing, they are bridging buyers and sellers, and therefore... “making a market”. Because they are quoting both sides of the market (i.e. quoting both buy and sell prices on the exchange), THEY are actually setting the day-to-day prices, not the “free market”. 

In the long term: yes, supply & demand win out. The fundamental value of the investment and all the actual stuff that should matter for an investment ultimately determines its price… but in the short term, Market Makers are one of the biggest forces pushing things in one direction or another. They make money off of the difference between the buy and sell prices they offer, called the “spread”. So, the more trading activity and volatility there is (regardless of whether prices are going up or down), the more money they make. Also, because they are the ones tilting the scales, they can ensure that all of their “buying & selling” ends up profitable for them no matter what.

In the short term, Markets are a Casino… and the house always wins.

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To illustrate how Market Makers tilt the scales in the short term, let’s look at an example:

Say Bitcoin is trading at $50k, and everyone thinks prices are going up to $60k next week, so tons of retail traders & “moonboys” jump in to get rich overnight. They buy Bitcoin, they buy Options, they leverage their bets, borrow money, etc, all the *not so smart* things that people do. These traders buy Bitcoin, and then set their “stop” at $48k. A “stop” is short for a “stop-loss order”, the price to automatically sell something, usually at a loss, and get out of a trade. So, in this case, if Bitcoin dropped to $48k, the traders would automatically have their holdings sold for a loss.

The Market Makers can see all of this data, entries, where traders put their stops, and everything else… because it is all done on the exchange. Also, people tend to follow the herd, follow similar popular “trading strategies” around charts, patterns, technical analysis, etc, and you’d be amazed how many people put their entries and stops in roughly the same place. The Market Makers also know all this, and the strategies traders are using, because they can see all of it live.

So, what happens next? Prices were at $50k, and maybe the price goes up a little, say to $55k, then, right about the time people get more confident and even more people jump in… prices start to dip. People get scared and sell, and prices magically drop down to $48k, “stopping out” all the leveraged and retail traders and taking their money. Whoops. Retail traders lose, Market Makers win.

Well, now, people get really negative about Bitcoin. “It’s below $50k! It’s definitely going down to $40k now, better go short!” (Going “short” is when you bet something will go down in price). So more traders pile in, and the news headlines get really bad, Bitcoin is going down. Seems like a smart trade to bet it’ll keep falling, so people open short positions, open option positions, leverage up, all the same stuff betting the opposite way… They all set their points to take profit if Bitcoin drops to $40k, and their stop (to close their position at a loss), if Bitcoin goes back up to $50k.

So what happens? Bitcoin goes down a little more, maybe to $45k… then all of a sudden, “the bulls are back in control!” and prices spike up to $50k, once again, “stopping out” all the leveraged and retail traders and taking their money. Retail traders lose, Market Makers win. Again.

The same basic thing happens again and again, day after day, year after year, decade after decade, century after century, in every market.

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It’s the same damn game, over and over. It’s all a big illusion manipulating people’s emotions to take their money, and the vast majority of people never catch on to what’s happening, or how they’re getting screwed.

They know it’s rigged, but they don’t know how.

The people who do figure it out, either learn to trade with the Market Makers (i.e. the top 1% of traders), or they opt out of the whole rigged game and opt to invest for the long term, where the odds are actually skewed in your favor. I would highly recommend the latter.

The best way to beat the market makers, is to not play their game.

Don’t trade, and don’t try to time the market.

To really drive this point home, let me give you a quote from a former Market Maker in the Stock Market that I met many years ago. He used to work directly for a major brokerage, actually the stock brokerage I personally used at the time. He would teach people about how markets worked, and about his former job, effectively screwing over the exchange’s own clients (the retail traders) by taking a cut out of them on every trade. He would always say:

 "My job wasn't to kill you, it was to bleed you slowly". 

- Former Market Maker

If you’re a trader, the exchange and specifically the Market Makers are not your friends, they are your opponents.

Now, Markets are very complex and dynamic things, and involve a lot more than just the Market Makers, and the retail buyers and sellers on their platforms. In the next section, we’ll cover another powerful predator, one that moves markets significantly, and influences everything around them.

Institutional Investors

In case the image above didn’t give it away, Institutional Investors are the tigers of the jungle. They are highly adept at moving silently to set up their attacks (often for months at a time), then striking at lightning speed when the moment is right. When they make their move, the markets move, all the smaller animals scatter. Their manipulation actually overlaps with, and often works in tandem with what Market Makers are doing.

Institutional Investors are the apex predators, because they control most of the money, and they are annoyingly good at hunting. You’re never going to beat them at their game, but fortunately you don’t need to! All you need to do is understand how they play the game, and learn how to not end up their prey.

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In traditional markets, there are a lot of entities that would qualify as institutional investors: Hedge Funds, Venture Capital Funds (VC), Private Equity Funds, Mutual Funds, Pension Funds, Investment Banks, Endowment Funds, and other money managers. Basically any big institution with a lot of money to manage or move around. Not all of these are problematic for your investing, since many are pretty straightforward long term holders that don’t disrupt markets too much. But… then there are those who are not only actively “trading”, but actively manipulating markets. Manipulating markets is their business. While oftentimes illegal activity may be happening, this is not necessarily illegal activity at all, because they can do everything they want to do perfectly legally. These active trading funds make money off of big market movements, and can make money when markets either go up or down. The direction doesn’t matter so much, it’s the big price movements they’re after.

So, while we’re just discussing crypto, I’m going to be simplifying Institutional Manipulation as primarily coming from actively trading entities like Hedge Funds and VC Funds. Plenty of more “traditional” funds will also move markets when they rebalance at the end of the quarter or year (often dropping the price as a result), but that isn’t malicious, it’s just normal market moves, so we’ll skip that for now.

Side note: Not all of these funds are bad, and it makes no sense to demonize all VC Funds. Investment capital is vital for an ecosystem to grow, and that is what VC firms provide. In fact, there are several Crypto VC Funds that I truly respect, are long term holders, and have helped build the crypto space. Funds like Pantera, Morgan Creek, A16z, Multicoin, Polychain, Grayscale, and others have led the charge in bringing massive amounts of capital into the system and are generally very well regarded by the crypto community. However, the majority of other VC firms have the reputation they do for a reason…

Is it difficult to manipulate markets?

Not at all. First, let’s establish that pushing the market one way or another is not that hard to do, especially in crypto, where liquidity (i.e. how much supply is available to buy or sell) is often very low. It’s estimated now that Institutional Investors control almost 90% of the money trading in crypto on a daily basis. This dynamic may be newer to the crypto world as more institutions enter, but it is already a well established dynamic in the Stock market and other more mature markets. A mentor of mine growing up, who had formerly worked on Wall Street at Merrill Lynch described this to me as a kid, saying:

“Every day, the institutional players had 90% of the money, and the retail traders had 10%. And every day, it was the 90% trying to take that last 10%”

- Former Merrill Lynch Trader

So, we now know that if any entity, or group of entities, has a giant amount of money to buy or sell, it will push the market one way or another. Then, when the market starts going that way, people will react to it. The general public (I.E. NOT long term investors) will either buy or sell depending on what’s happening. “Oh no! The price is crashing, better sell!” or “Yes! Prices are going up, better double down and take out leverage!”. These are the same emotions the Market Makers play on. People are pretty predictable unfortunately, and these movements can be actually choreographed by the institutions being smart about how and when they buy & sell.

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To illustrate how Institutional Investors manipulate markets in the short and medium term, let’s look at an example

Exhibit A: Wyckoff Distribution

While manipulation in crypto is nothing new (“whales”, or large crypto holders that can move markets is a very common term), with the entrance of more large institutional players in recent years, market manipulation in crypto has gone pro. We’ve gone from these scattered attacks and random market moves driven by a handful of folks, to much more organized and intelligent manipulation, over the course of months (or years).

So, that brings us to a pattern of manipulation apparent in virtually all markets that is so well documented, it has its own name, and tons of books written about it. It’s named after Richard Wyckoff, who got so pissed off seeing the same patterns of market manipulation over and over that he actually studied them, dissected them, and documented them. We were all treated to this manipulation pattern with the crypto crash in May of 2021, which caught many of us (myself included) completely off guard, since it interrupted the “historical” crypto cycle flow we were all expecting. The big institutions were finally here, and this was one of their calling cards.

The Wyckoff Distribution pattern has four stages: 1) accumulation, 2) markup, 3) distribution, 4) markdown.

One of the few people who actually caught this before it played out was the YouTube channel Uncomplication. If you’re interested in the video he posted discussing this (actually before it happened), you can check it out here.

Now, simple logic states that institutions want to buy low and sell high, right? So, why can’t institutions just buy something really cheap, then push the market up, then dump their holdings? Well, it would immediately crash the price, they wouldn’t have enough buyers (read: suckers) to sell all their holdings to, and it would be too obvious to get many in the general public to fall for. People aren’t always the brightest… but they aren’t that dense. So, institutions need to get more sophisticated.

The gist of a Wyckoff Distribution is for institutions to accumulate an asset at a low price slowly and quietly (the “accumulation phase”), to amass as much as they can to maximize their profits. This is because if they buy too much at one time, it will spike the price prematurely. Then, the price is pushed up higher, until the public starts to notice and more people pile in (the “markup phase”). Then, the price really takes off! There is a big move to the upside and the institutions are sitting on a ton of unrealized profit. But… they don’t want unrealized profit. They want to sell, take that profit, and go do the whole thing over again.

So, what do they do? They gradually sell their holdings at these new higher prices over time, to not crash the market (the “distribution phase”). The new retail buyers entering the market buy up their shares at high prices, and then finally, once institutions have unloaded most of their shares and are sitting on a mountain of new profits, they crash the price (the “markdown phase”). In fact, they might even short the market to make additional money on the way down.

Kinda pisses you off right?

It gets even better though. As the price crashes, people panic sell. Prices drop and drop until they eventually stabilize at some much lower price. People lose savings, homes, and all kinds of other things without knowing why. “The market crashed” is all they know, they don’t know it’s all a big show. Then, the institutions start slowly accumulating again at low prices, just to play the same damn game over again (or move to another asset and do it there).

This happens over, and over, and over, everywhere.

This is especially common around big events that happen in the market. The lead up to a big event is often filled with hype and price appreciation, then, when the event actually happens, prices often crash (the institutional players sold ahead of time to all the excited, eager buyers). This is called “buy the rumor, sell the news”.

Remember this for big events in the crypto space! (i.e. ETF approvals, Ethereum 2.0 unlock, etc)

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Well, if it’s so simple, why don’t we just look at the patterns and buy and sell when institutions do? Well, you actually can try to do that. It’s at least smarter than most trading strategies, and isn’t the worst idea honestly. But, the thing is… that is still much easier said than done. Markets are dynamic, and the same exact thing never happens twice, though similar patterns do reoccur frequently. So, if everyone catches on to one pattern of manipulation, they’ll just change it to another pattern. It’s a losing proposition to keep guessing and trying to time it all the time, and you’re always at a disadvantage. Not the kind of odds you want as an investor.

As a side note: if you’re sitting there thinking “they can’t do that! That’s market manipulation, they’ll all go to jail! They’re conspiring to defraud the public!” well… bad news. Most of this happens (or at least can happen) without these many institutions ever actually talking with each other. All completely legal.

It’s because they all know the rules of the game, and can act accordingly without explicitly communicating, it’s just the general public who is left in the dark.

Wyckoff called this idea the Composite Man, which is a very intelligent way to frame it, let’s look at what he said explicitly:

…all the fluctuations in the market and in all the various stocks should be studied as if they were the result of one man’s operations. Let us call him the Composite Man, who, in theory, sits behind the scenes and manipulates the stocks to your disadvantage if you do not understand the game as he plays it; and to your great profit if you do understand it.

- Richard Wyckoff

Doesn’t all this sound eerily similar to what Market Makers do too?

Pushing things just enough in one direction or another to get YOU feeling emotional enough to do something with your money? Yep. That’s pretty much what every kind of market manipulation is designed to get you to do.

Institutions are always trying to get you to either 1) scare you into selling to them when prices are down, or 2) entice you to buy from them when prices are up.

It’s the same game, over and over again.

There are many more kinds of manipulation too, hell you see some of them in broad daylight. Bill Ackman, a very famous Hedge Fund manager, got on TV in early 2020 to freak the entire market out about COVID, while publicly selling a large amount of shares, and shorting the market. He did countless interviews, TV spots, and had headlines with his highly dramatized quote of “hell is coming”.

He maintained his rhetoric until markets crashed… and right at the bottom, once countless people had taken huge losses… he closed his short positions, and bought everything back at a fraction of the price from the people who freaked out. Then thanks to the Fed, markets turned around and shot right back up. He made a fortune on both on the way down, and the way back up. That trade turned $27 million into $2.6 billion, and he was hailed as a god. Perfectly legal.

This is the kind of behavior you’re up against. This is why more than 95% of traders lose money, and this is the kind of manipulation you need to not fall prey to.

From now on, when you see markets do something crazy, spike or crash… Just remember: Market’s don’t move… Market’s are moved.

Media Headlines

One last quick thing to call out. What about the media and the new headlines? They seem to be highly complicit here don’t they? They seem to be only positive with crazy price predictions while things are going up, then switch to doom and gloom whenever prices are going down. This conveniently exacerbates everything the market makers and institutional investors do, and makes them far more effective in manipulating the market.

So is the media in on this too? Do we need to get out our tinfoil hats?? Well, yes and no. While of course there are tons of stories that are planted, no surprise there, we don’t need to resort to any kind of conspiracy to explain this behavior.

News outlets aren’t typically malicious. They publish whatever people will click on, and they have every incentive to amplify the mood of the moment, because those headlines resonate most with the people clicking. When prices are going up, “everything is awesome!”, because that’s what people will click on. No one wants to hear some downer talking about downside risk when we’re going straight to the moon. Then, when prices are crashing, and fear takes over… “everything is terrible! we’re going to zero!”, because that’s what fearful people will click on, and most people are thinking just in price, not fundamental value.

And there you go. No need for a grand conspiracy. Collective behavior can once again be explained by just looking at 1) how the system works, 2) people’s incentives, and 3) group psychology.

P.S. Guess where the manipulative behavior from all sources peaks? Memecoins. 🙃