Spoofing (finance)

From Wikipedia, the free encyclopedia

Spoofing is a disruptive algorithmic trading entity employed by traders to outpace other market
participants and to manipulate commodity markets.[1][2][3] Spoofers feign interest in trading
futures, stocks and other products in financial markets creating an illusion of exchange
pessimism in the futures market when many offers are being cancelled or withdrawn, or false
optimism or demand when many offers are being placed in bad faith.[4] 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 high-frequency traders (HFT) to induce a particular market
reaction such as manipulating the market price of a security. 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.[2][5][6] Under the 2010 Dodd-Frank Act spoofing is
defined as "the illegal practice of bidding or offering with intent to cancel before
execution."[1][7] Spoofing can be used with layering algorithms and front-running,[8] activities
which are also illegal.[1][3] High-frequency trading, the primary form of algorithmic trading used in
financial markets is very profitable as it deals in high volumes of transactions.[9][10][11][12][13][14] The
five-year delay in arresting the lone spoofer, Navinder Singh Sarao, accused of exacerbating
the 2010 Flash Crashone of the most turbulent periods in the history of financial markets
has placed the self-regulatory bodies such as the Commodity Futures Trading
Commission (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.[15]

Contents
[hide]

1Definition
2Milestone case against spoofing
3Providence vs Wall Street
4DoddFrank Wall Street Reform and Consumer Protection Act
52010 Flash Crash and the lone Hounslow day-trader
6References
7See also

Definition[edit]
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."[16]
In a 2012 report Finansinspektionen (FI), the Swedish Financial Supervisory
Authority[17] 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."[7]
In the U.S. Department of Justice April 21, 2015 complaint of market manipulation and fraud
laid against Navinder Singh Sarao,[18] dubbed the Hounslow day-trader[19] 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."[20] 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.[20]

Milestone case against spoofing[edit]

In July 2013 the US Commodity Futures Trading Commission (CFTC) and Britain's Financial
Conduct Authority (FCA) brought a milestone case against spoofing which represents the first
Dodd-Frank Act application.[1] A federal grand jury in Chicago indicted Panther Energy Trading
and Michael Coscia, a high-frequency trader. 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.[6] 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 Groups Globex trading platform."[1] 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."[1]
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."[1]

Providence vs Wall Street[edit]

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, Nasdaq, Better Alternative Trading System (Bats)
an electronic communication network (ECN)[21] and Direct Edge among others. The suit also
names major Wall Street firms including but not limited to, Goldman
Sachs, Citigroup, JPMorgan and the Bank of America. High-frequency trading firms and hedge
funds are also named in the lawsuit.[22] 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."[22]

DoddFrank Wall Street Reform and Consumer Protection

Act[edit]
Main article: DoddFrank Wall Street Reform and Consumer Protection Act
CFTCs Enforcement Director, David Meister, explained the difference between legal and
illegal use of algorithmic trading,[1]
While forms of algorithmic trading are of course lawful, using a computer program that is
written to spoof the market is illegal and will not be tolerated. We will use the Dodd Frank anti-
disruptive practices provision against schemes like this one to protect market participants and
promote market integrity, particularly in the growing world of electronic trading platforms."

David Meister CFTC 2013

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."[2]Anti-spoofing
statute is part of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act
passed in July 21, 2010. The Dodd-Frank brought significant changes to financial regulation in
the United States.[23][24] 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.[25][26][27]
Eric Moncada, another trader is accused of spoofing in wheat futures markets and faces CFTC
fines of $1.56 million.[5][2]

2010 Flash Crash and the lone Hounslow day-trader[edit]

Main article: 2010 Flash Crash
On April 21, 2015, five years after the incident, the U.S. Department of Justice laid "22 criminal
counts, including fraud and market manipulation"[18] 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.[18] 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.[18] Spoofing, layering and front-running are now banned.[3] 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.[18] 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."[18] Sarao
is a 36-year-old small-time trader who worked from his parents modest semi-attached stucco
house in Hounslow in suburban west London.[18] 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.[3][4] 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") 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.[4]
The 2010 Flash Crash[28] was a United States trillion-dollar[3] stock market crash,[29]:1 in which the
"S&P 500, the Nasdaq 100, and the Russell 2000 collapsed and rebounded with extraordinary
velocity."[29] Dow Jones Industrial Average "experienced the biggest intraday point decline in its
entire history,"[29] plunging 998.5 points (about 9%), most within minutes, only to recover a large
part of the loss.[30][31][32][33] A CFTC 2014 report described it as one of the most turbulent periods
in the history of financial markets.[1]
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 worlds biggest companies
were in freefall. They appeared to be in a race to zero. Peak to trough."[34]:2 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."[34]:2
"The Flash Crash was a near miss. It taught us something important, if uncomfortable, about
our state of knowledge of modern financial markets. Not just that it was imperfect, but that
these imperfections may magnify, sending systemic shockwaves. Technology allows us to thin-
slice time. But thinner technological slices may make for fatter market tails. Flash Crashes, like
car crashes, may be more severe the greater the velocity. Physical catastrophes alert us to the
costs of ignoring these events, of normalizing deviance. There is nothing normal about recent
deviations in financial markets. The race to zero may have contributed to those abnormalities,
adding liquidity during a monsoon and absorbing it during a drought. This fattens tail risk.
Understanding and correcting those tail events is a systemic issue. It may call for new rules of
the road for trading. Grit in the wheels, like grit on the roads, could help forestall the next
crash."

Andrew Haldane, Bank of England July 8, 2011 page 18