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NASDAQ CASE STUDY: Identifying the Signature of Spoofing

Traders Magazine Online News, June 15, 2017

Alan Jukes

In this shared insight, exchange operator NASDAQ discusses ways to identify spoofers and how to combat them. 

Defintion:

‘Spoofing’ is a form of market manipulation whereby a participant creates a false and misleading impression of the supply/demand of a financial instrument in order to benefit from its influence. This false impression enables the ‘spoofer’ to transact at levels that may not have been previously obtainable, and are unlikely to be available in the absence of the false orders. By executing in this way, the ‘spoofer’ gains an unfair advantage in the market and profits as a result. 

 

Spoofing’ is under very high scrutiny at the moment, following several recent high profile cases, including the criminal prosecution of Michael Coscia (Panther Trading), and financial sanctions against Igor Oystacher (3Red), Citigroup, and Navinder Sarao. ‘Spoofing’ occurs when a trader gives other market participants the (false) impression that ‘something’ is about to happen, that ‘something’ could be heavy buying or heavy selling, resulting in price movement, and is created using large flows of orders to one side of the book. This influx of orders persuades other market participants to trade, in the belief that the volume will continue into the book, and move the price in that direction, which they can then profit from. Many Automated Trading Systems (ATS) consider the volume in the order book as a determining factor in identifying market momentum and direction. Given the rapid nature of the activity, in highly liquid markets, often the ‘victim’ of spoofing is an ATS.

A successful ‘spoofer’ can profit from an ATS, by creating all of the conditions required for the ATS to buy or sell, transacting with the ATS, then removing those conditions. Because the ATS is invariably only seeking a short term profit, it will often immediately close out to a loss if a profit isn’t available, to avoid market risk. In addition, very few ATS systems are positional strategies over a period of more than a few seconds – instead they seek to optimize the market through arbitrage and potentially get ahead of any short term market movements.

The core function of an ATS is built around the belief that the order book only comprises orders that are intended to trade and is a ‘true’ reflection of supply and demand. Furthermore, an ATS doesn’t have the ability to ‘distrust’ the market after a few ‘spoofing’ events, in the same way a manual trader might back away from a market if they think they are being ‘spoofed’. This makes it possible to generate profit from these ATS traders, by ‘fooling’ them into trading and causing significant disruption to the market.

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