Spoofing (finance)
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Spoofing is a disruptive
algorithmic trading Algorithmic trading is a method of executing orders using automated pre-programmed trading instructions accounting for variables such as time, price, and volume. This type of trading attempts to leverage the speed and computational resources of ...
activity employed by traders to outpace other market participants and to manipulate markets. Spoofers feign interest in trading futures, stocks and other products in financial markets creating an illusion of the demand and supply of the traded asset. In an order driven market, spoofers post a relatively large number of limit orders on one side of the limit order book to make other market participants believe that there is pressure to sell (limit orders are posted on the offer side of the book) or to buy (limit orders are posted on the bid side of the book) the asset. Spoofing may cause prices to change because the market interprets the one-sided pressure in the limit order book as a shift in the balance of the number of investors who wish to purchase or sell the asset, which causes prices to increase (more buyers than sellers) or prices to decline (more sellers than buyers). Spoofers bid or offer with intent to cancel before the orders are filled. The flurry of activity around the buy or sell orders is intended to attract other traders to induce a particular market reaction. Spoofing can be a factor in the rise and fall of the price of shares and can be very profitable to the spoofer who can time buying and selling based on this manipulation. Under the 2010 Dodd–Frank Act spoofing is defined as "the illegal practice of bidding or offering with intent to cancel before execution." Spoofing can be used with
layering Layering has evolved as a common means of vegetative propagation of numerous species in natural environments. Layering is also utilized by horticulturists to propagate desirable plants. Natural layering typically occurs when a branch touches ...
algorithms and front-running, activities which are also illegal. High-frequency trading, the primary form of
algorithmic trading Algorithmic trading is a method of executing orders using automated pre-programmed trading instructions accounting for variables such as time, price, and volume. This type of trading attempts to leverage the speed and computational resources of ...
used in financial markets is very profitable as it deals in high volumes of transactions. The five-year delay in arresting the lone spoofer, Navinder Singh Sarao, accused of exacerbating the 2010 Flash Crash—one of the most turbulent periods in the history of financial markets—has placed the self-regulatory bodies such as the
Commodity Futures Trading Commission The Commodity Futures Trading Commission (CFTC) is an independent agency of the US government created in 1974 that regulates the U.S. derivatives markets, which includes futures, swaps, and certain kinds of options. The Commodity Exchange Ac ...
(CFTC) and Chicago Mercantile Exchange & Chicago Board of Trade under scrutiny. The CME was described as being in a "massively conflicted" position as they make huge profits from the HFT and algorithmic trading.


Definition

In Australia layering and spoofing in 2014 referred to the act of "submitting a genuine order on one side of the book and multiple orders at different prices on the other side of the book to give the impression of substantial supply/demand, with a view to sucking in other orders to hit the genuine order. After the genuine order trades, the multiple orders on the other side are rapidly withdrawn." In a 2012 report Finansinspektionen (FI), the Swedish Financial Supervisory Authority defined spoofing/layering as "a strategy of placing orders that is intended to manipulate the price of an instrument, for example through a combination of buy and sell orders." In the U.S. Department of Justice April 21, 2015 complaint of
market manipulation In economics and finance, market manipulation is a type of market abuse where there is a deliberate attempt to interfere with the free and fair operation of the market; the most blatant of cases involve creating false or misleading appearances ...
and fraud laid against Navinder Singh Sarao, — dubbed the Hounslow day-trader — appeared "to have used this 188-and-289-lot spoofing technique in certain instances to intensify the manipulative effects of his dynamic layering technique...The purpose of these bogus orders is to trick other market participants and manipulate the product's market price." He employed the technique of dynamic layering, a form of market manipulation in which traders "place large sell orders for contracts" tied to the Standard & Poor's 500 Index. Sarao used his customized computer-trading program from 2009 onwards.


Milestone case against spoofing

In July 2013 the US
Commodity Futures Trading Commission The Commodity Futures Trading Commission (CFTC) is an independent agency of the US government created in 1974 that regulates the U.S. derivatives markets, which includes futures, swaps, and certain kinds of options. The Commodity Exchange Ac ...
(CFTC) and Britain's
Financial Conduct Authority The Financial Conduct Authority (FCA) is a financial regulation, financial regulatory body in the United Kingdom, but operates independently of the UK Government, and is financed by charging fees to members of the financial services industry. The ...
(FCA) brought a milestone case against spoofing which represents the first Dodd-Frank Act application. A federal grand jury in Chicago indicted Panther Energy Trading and Michael Coscia, a
high-frequency trader High-frequency trading (HFT) is a type of algorithmic financial trading characterized by high speeds, high turnover rates, and high order-to-trade ratios that leverages high-frequency financial data and electronic trading tools. While there is no ...
. In 2011 Coscia placed spoofed orders through CME Group Inc. and European futures markets with profits of almost $1.6 million. Coscia was charged with six counts of spoofing with each count carrying a maximum sentence of ten years in prison and a maximum fine of one million dollars. The illegal activity undertaken by Coscia and his firm took place in a six-week period from "August 8, 2011 through October 18, 2011 on CME Group’s Globex trading platform." They used a "computer algorithm that was designed to unlawfully place and quickly cancel orders in exchange-traded futures contracts." They placed a "relatively small order to sell futures that they did want to execute, which they quickly followed with several large buy orders at successively higher prices that they intended to cancel. By placing the large buy orders, Mr. Coscia and Panther sought to give the market the impression that there was significant buying interest, which suggested that prices would soon rise, raising the likelihood that other market participants would buy from the small order Coscia and Panther were then offering to sell." Britain's FCA is also fining Coscia and his firm approximately $900,000 for "taking advantage of the price movements generated by his layering strategy" relating to his market abuse activities on the ICE Futures Europe exchange. They earned US$279,920 in profits over the six weeks period "at the expense of other market participants – primarily other High Frequency Traders or traders using algorithmic and/or automated systems."


Providence vs Wall Street

On 18 April 2014 Robbins Geller Rudman & Dowd LLP filed a class-action lawsuit on behalf of the city of Providence, Rhode Island in Federal Court in the Southern District of New York. The complaint in the high frequency matter named "every major stock exchange in the U.S." This includes the
New York Stock Exchange The New York Stock Exchange (NYSE, nicknamed "The Big Board") is an American stock exchange in the Financial District of Lower Manhattan in New York City. It is by far the world's largest stock exchange by market capitalization of its listed c ...
,
Nasdaq The Nasdaq Stock Market () (National Association of Securities Dealers Automated Quotations Stock Market) is an American stock exchange based in New York City. It is the most active stock trading venue in the US by volume, and ranked second ...
, Better Alternative Trading System (Bats) — an
electronic communication network An electronic communication network (ECN) is a type of computerized forum or network that facilitates the trading of financial products outside traditional stock exchanges. An ECN is generally an electronic system that widely disseminates orders e ...
(ECN) and
Direct Edge Direct Edge was a Jersey City, New Jersey-based stock exchange operating two separate platforms, EDGA Exchange and EDGX Exchange. Beginning in March 2009, Direct Edge's market share ranged from 9% to 12% of U.S. equities trading volume, and r ...
among others. The suit also names major Wall Street firms including but not limited to,
Goldman Sachs Goldman Sachs () is an American multinational investment bank and financial services company. Founded in 1869, Goldman Sachs is headquartered at 200 West Street in Lower Manhattan, with regional headquarters in London, Warsaw, Bangalore, H ...
,
Citigroup Citigroup Inc. or Citi (Style (visual arts), stylized as citi) is an American multinational investment banking, investment bank and financial services corporation headquartered in New York City. The company was formed by the merger of banking ...
,
JPMorgan JPMorgan Chase & Co. is an American multinational investment bank and financial services holding company headquartered in New York City and incorporated in Delaware. As of 2022, JPMorgan Chase is the largest bank in the United States, the w ...
and the
Bank of America The Bank of America Corporation (often abbreviated BofA or BoA) is an American multinational investment bank and financial services holding company headquartered at the Bank of America Corporate Center in Charlotte, North Carolina. The bank w ...
. High-frequency trading firms and
hedge funds A hedge fund is a pooled investment fund that trades in relatively liquid assets and is able to make extensive use of more complex trading, portfolio-construction, and risk management techniques in an attempt to improve performance, such as shor ...
are also named in the lawsuit. The lawsuit claimed that, "For at least the last five years, the Defendants routinely engaged in at least the following manipulative, self-dealing and deceptive conduct," which included "spoofing – where the HFT Defendants send out orders with corresponding cancellations, often at the opening or closing of the stock market, in order to manipulate the market price of a security and/or induce a particular market reaction."


Dodd–Frank Wall Street Reform and Consumer Protection Act

CFTC's Enforcement Director, David Meister, explained the difference between legal and illegal use of algorithmic trading, It is "against the law to spoof, or post requests to buy or sell futures, stocks and other products in financial markets without intending to actually follow through on those orders." Anti-spoofing statute is part of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act passed on July 21, 2010. The Dodd-Frank brought significant changes to
financial regulation Financial regulation is a form of regulation or supervision, which subjects financial institutions to certain requirements, restrictions and guidelines, aiming to maintain the stability and integrity of the financial system. This may be handled ...
in the United States. It made changes in the American financial regulatory environment that affect all federal financial regulatory agencies and almost every part of the nation's financial services industry. Eric Moncada, another trader is accused of spoofing in wheat futures markets and faces CFTC fines of $1.56 million.


2010 Flash Crash and the lone Hounslow day-trader

On April 21, 2015, five years after the incident, the U.S. Department of Justice laid "22 criminal counts, including fraud and market manipulation" against Navinder Singh Sarao, who became known as the Hounslow day-trader. Among the charges included was the use of spoofing algorithms, in which first, just prior to the Flash Crash, he placed thousands of E-mini S&P 500 stock index futures contract orders. These orders, amounting to about "$200 million worth of bets that the market would fall" were "replaced or modified 19,000 times" before they were cancelled that afternoon. Spoofing, layering and front-running are now banned. The CTFC concluded that Sarao "was at least significantly responsible for the order imbalances" in the derivatives market which affected stock markets and exacerbated the flash crash. Sarao began his alleged market manipulation in 2009 with commercially available trading software whose code he modified "so he could rapidly place and cancel orders automatically." Sarao is a 36-year-old small-time trader who worked from his parents’ modest semi-attached stucco house in
Hounslow Hounslow () is a large suburban district of West London, west-southwest of Charing Cross. It is the administrative centre of the London Borough of Hounslow, and is identified in the London Plan as one of the 12 metropolitan centres in Gr ...
in suburban west London. ''Traders Magazine'' correspondent John Bates argues that by April 2015, traders can still manipulate and impact markets in spite of regulators and banks' new, improved monitoring of automated trade systems. For years, Sarao denounced high-frequency traders, some of them billion-dollar organisations, who mass manipulate the market by generating and retract numerous buy and sell orders every millisecond ("
quote stuffing In finance, quote stuffing refers to a form of market manipulation employed by high-frequency traders (HFT) that involves quickly entering and withdrawing a large number of orders in an attempt to flood the market. This can create confusion in th ...
") — which he witnessed when placing trades at the Chicago Mercantile Exchange (CME). Sarao claimed that he made his choices to buy and sell based on opportunity and intuition and did not consider himself to be one of the HFTs. The 2010 Flash Crash was a United States trillion-dollar
stock market crash A stock market crash is a sudden dramatic decline of stock In finance, stock (also capital stock) consists of all the shares by which ownership of a corporation or company is divided.Longman Business English Dictionary: "stock - ''especia ...
, in which the "S&P 500, the Nasdaq 100, and the Russell 2000 collapsed and rebounded with extraordinary velocity."
Dow Jones Industrial Average The Dow Jones Industrial Average (DJIA), Dow Jones, or simply the Dow (), is a stock market index of 30 prominent companies listed on stock exchanges in the United States. The DJIA is one of the oldest and most commonly followed equity inde ...
"experienced the biggest intraday point decline in its entire history," plunging 998.5 points (about 9%), most within minutes, only to recover a large part of the loss. A CFTC 2014 report described it as one of the most turbulent periods in the history of financial markets. In 2011 the chief economist of the Bank of England — Andrew Haldane — delivered a famous speech entitled the "Race to Zero" at the International Economic Association Sixteenth World Congress in which he described how "equity prices of some of the world’s biggest companies were in freefall. They appeared to be in a race to zero. Peak to trough." At the time of the speech Haldane acknowledged that there were many theories about the cause of the Flash Crash but that academics, governments and financial experts remained "agog."


References


See also

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Algorithmic trading Algorithmic trading is a method of executing orders using automated pre-programmed trading instructions accounting for variables such as time, price, and volume. This type of trading attempts to leverage the speed and computational resources of ...
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Complex event processing Event processing is a method of tracking and analyzing (processing) streams of information (data) about things that happen (events), and deriving a conclusion from them. Complex event processing, or CEP, consists of a set of concepts and techniques ...
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Computational finance Computational finance is a branch of applied computer science that deals with problems of practical interest in finance.Rüdiger U. Seydel, '' tp://nozdr.ru/biblio/kolxo3/F/FN/Seydel%20R.U.%20Tools%20for%20Computational%20Finance%20(4ed.,%20Spring ...
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Dark liquidity In finance, a dark pool (also black pool) is a private forum (alternative trading system or ATS) for trading securities, derivatives, and other financial instruments.Data mining *
Erlang (programming language) Erlang ( ) is a general-purpose, concurrent, functional programming language, and a garbage-collected runtime system. The term Erlang is used interchangeably with Erlang/OTP, or Open Telecom Platform (OTP), which consists of the Erlang run ...
used by
Goldman Sachs Goldman Sachs () is an American multinational investment bank and financial services company. Founded in 1869, Goldman Sachs is headquartered at 200 West Street in Lower Manhattan, with regional headquarters in London, Warsaw, Bangalore, H ...
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Flash trading Flash trading, otherwise known as a flash order, is a marketable order sent to a market center that is not quoting the industry's best price or that cannot fill that order in its entirety. The order is then flashed to recipients of the venue's prop ...
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Front running Front running, also known as tailgating, is the prohibited practice of entering into an equity ( stock) trade, option, futures contract, derivative, or security-based swap to capitalize on advance, nonpublic knowledge of a large ("block") pend ...
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Hedge fund A hedge fund is a pooled investment fund that trades in relatively liquid assets and is able to make extensive use of more complex trading, portfolio-construction, and risk management techniques in an attempt to improve performance, such as sho ...
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Hot money In economics, hot money is the flow of funds (or capital) from one country to another in order to earn a short-term profit on interest rate differences and/or anticipated exchange rate shifts. These speculative capital flows are called "hot money" b ...
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IEX Investors Exchange (IEX) is a stock exchange in the United States. It was founded in 2012 in order to mitigate the effects of high-frequency trading. IEX was launched as a national securities exchange in September 2016. On October 24, 2017, it ...
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Market maker A market maker or liquidity provider is a company or an individual that quotes both a buy and a sell price in a tradable asset held in inventory, hoping to make a profit on the ''bid–ask spread'', or ''turn.'' The benefit to the firm is that it ...
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Mathematical finance Mathematical finance, also known as quantitative finance and financial mathematics, is a field of applied mathematics, concerned with mathematical modeling of financial markets. In general, there exist two separate branches of finance that require ...
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Offshore fund An offshore fund is generally a collective investment scheme domiciled in an offshore jurisdiction. Like the term "offshore company", the term is more descriptive than definitive, and both the words 'offshore' and 'fund' may be construed differen ...
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Pump and dump Pump and dump (P&D) is a form of securities fraud that involves artificially inflating the price of an owned stock through false and misleading positive statements, in order to sell the cheaply purchased stock at a higher price. Once the operat ...
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Quantitative trading Mathematical finance, also known as quantitative finance and financial mathematics, is a field of applied mathematics, concerned with mathematical modeling of financial markets. In general, there exist two separate branches of finance that require ...
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Short (finance) In finance, being short in an asset means investing in such a way that the investor will profit if the value of the asset falls. This is the opposite of a more conventional " long" position, where the investor will profit if the value of ...
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Statistical arbitrage In finance, statistical arbitrage (often abbreviated as ''Stat Arb'' or ''StatArb'') is a class of short-term financial trading strategies that employ mean reversion models involving broadly diversified portfolios of securities (hundreds to thousan ...
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