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What Is a False Market?

G. Wiesen
G. Wiesen

A false market is basically a type of investment environment in which the accurate values of different companies or shares cannot be determined due to some form of misrepresentation. For example, if a company is aware that it will not hit its projected goals for a fiscal year, it is obliged to share that information with investors. By not divulging that fact, however, the company can then maintain projected earnings that are unrealistic, but which are likely to be advantageous for the company. This creates a false market in which individuals and brokers are likely to overestimate the proper value of that company.

There are a few different ways in which a false market can be created, and they can be advantageous for various individuals. One simple way in which this can occur is in a situation in which a company does not properly disclose the details of its fiscal projections. At the beginning of a business year, companies often provide information regarding growth over that year. Investors can then use these projections to gauge the expected value of the company and potentially purchase shares.

The spread of negative rumors about a company can contribute to a false market.
The spread of negative rumors about a company can contribute to a false market.

As the year progresses, the business is typically required to reveal information about the state of those original projections on a fairly regular basis. For example, if the company had declared that 1000 units had to be sold over that year for it to reach its goals, then regular updates might indicate how sales are progressing. Six months into the year, if the company has sold 500 units, then it is on target for the projected goal. This type of disclosure prevents a false market, since investors are aware of how the business is doing and can respond to this information accordingly.

A false market can occur if the company does not properly reveal information about its progress toward a goal. If the company does not, for example, reveal that after nine months it has still only sold 500 of the 1000 necessary units, then this could create unrealistic expectations for investors. A false market is created in this way; investors and brokers do not know all of the information they need for share values to be accurate. In this way, the value of a company is likely to be viewed as higher than it should be, allowing a business to make greater profits on shares than it should.

The opposite type of effect can also be the result of a false market, which can damage an otherwise stable company. People can spread negative rumors and lies about the value of a company in a harmful manner, such as incorrect profit or loss projections. As this information becomes accepted by investors the overall value of the company’s shares can fall. This results in a false market in which a competitor or other business might then manage a takeover of the maligned company.

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    • The spread of negative rumors about a company can contribute to a false market.
      By: schwede-photodesign
      The spread of negative rumors about a company can contribute to a false market.