Why Is Spoofing Bad?
bloombergview.com
bloombergview.com
This would all be corrected if the exchanges charged money for cancelled orders. These traders are placing orders on a massive basis at prices they never intended to honor in order to get the exhanges to transmit these fake prices and trick others into action. (Often cancelling 100x the orders they transact). This is called "price-fraud", "spamming", and "market manipulation" in other parts of the economy.
Exchanges should charge a transaction for orders when they are placed... Not solely if they are executed. It is actually a fairer system since exchanges have to bear the cost of transmitting prices, volume, book depth, etc. on order placement... It could actually drive transaction fees down for those who cancel infrequently too (people trading for true commercial purposes) since the exhanges could average down thr cost of their transactions with mass-cancelers and they can trade with better information.
Oh, and unloading or buying large blocks of stock SHOULD move the market... by definition. Allowing people to mask that is a manipulation as well.
It's the reason that, even after tens of billions of dollars in fines, there have been no criminal cases brought against those in the big banks, while this guy faces a maximum sentence of 380 years if found guilty on all charges [0]
Spoofing is best handled by the particular exchanges but should be weighed against the harm it would do to honest market makers who have to place and cancel orders regularly
> In looking at Mr. Holder’s legacy in white-collar crime cases, the pursuit of corporations, especially banks, stands out. The highest settlements for violations have come in the last year. These include the $13 billion from JPMorgan Chase and the $16.65 billion from Bank of America for their roles in issuing mortgage-backed securities tied to faulty subprime loans. BNP Paribas also paid a $9 billion fine for violating economic sanctions laws. BNP was also required to enter a guilty plea to a criminal charge, a rarity in the world of corporate criminal prosecutions. But prosecutors did not file charges against any individuals for the wrongdoing that led to the large settlements. [1]
[0] http://www.telegraph.co.uk/finance/financial-crime/11554471/... [1] http://dealbook.nytimes.com/2014/09/29/eric-holders-mixed-le...
1) As this article describes, spoofing is the use of orders to change the perception of the supply and demand of an instrument. It is often also called layering (a term that is also overloaded). It does not involve mass amounts of orders or cancels. In fact, good spoofers go to great lengths to make their order flow look identical to someone who has regular trading intentions.
2) Spamming lots of orders into an exchange for some nefarious purpose (I've heard this described as a DDoS on the exchange). Which is both widely over reported (to the point that I believe it is largely urban myth) and trivial to detect and prevent on the exchange side (the exchanges know exactly who is sending the orders, the specific order gateways have rate limits, etc).
Finally, exchanges do penalize market participants that cancel too many orders. This is typically done via a fill ratio (the % of orders to those that trade) and enforcement can be either in the form of price levels, fees or potentially banning from the exchange.
This is functionally identical to spoofing except that these people are explicitly hoping to get a fill. (Hence it's legal.)
Its even worse in pro-rata matched markets because participants will often put orders in at much higher quantities than they actually want to trade, so that they can get any of the fills. That is, they'd love to get filled for 100 contracts, but are putting in orders for 10000 contracts in order to get any of the matching. Again, if that filled in the proper order they'd happily trade it, but if not they don't want to.
So in both cases, spoofing and not spoofing, the actual ability to honor the orders is in question. So that in and of itself is not evidence of spoofing.
The difference (I believe) is that the market makers in the laddering cases would LOVE to trade every single one of those orders if it came in the right order and are not intending to change the markets behavior with the placing of those orders.
Markets work, despite this incredibly misaligned incentive, because markets can eventually reward people who are eventually more correctly predicting the future value of the assets.
FYI - your usage of the phrase "true price" makes me strongly confident that you totally misunderstand markets.
[1] http://www.bloombergview.com/articles/2015-01-23/high-freque...
This is available currently in the form of dark pools. They don't tend to work out as liquidity is much lower on them and bid/ask spreads are wider.
That may not be true if ALL venues were required to be private, but that would be a pretty dramatic change (and exactly the opposite of what we have now, which is a requirement to publish and meet other published prices).
If you're a big institutional investor though, and you know that buying a bunch of shares will move the market for sure, well, it might be worth suffering a wider spread. As long as that spread looks small relative to how much you think you'll move the market, it's not a bad deal. And if you already have a subscription to the pool you might as well try it before you get the algorithms involved to buy on the open market.
Dark Pools were meant to provide that, but it turns out that in practice it didn't work (because no one wants to provide liquidity in that environment) and Dark Pools ended up resorting to either letting liquidity providers in, going out of business, or extremely scammy things to keep up the ruse.
So if you are using a liquidity providers it is evidence that you do not want to wait. If you did want to wait, you yourself can just put the order out and provide the liquidity to others.
I was suggesting something much more like a txn fee per order closed above a much tighter threshold (like 3x)
And none of those limits currently apply to registered market makers... And I agree with their exemption from the harsher rule too, but they should bear increased scrutiny and guaranteed liquidity rules for the privilege.
If a trade occurs at $10.00 and then the next trade is $12.00, that's considered "not orderly". So a market maker must keep orders at $10.00, $10.20, $10.40, ..., $11.80, $12.00. This way if someone comes in and buys everything then the sequence of trades will be $10.00, $10.20, $10.40, etc.
My comment is getting hammered with downvotes now.... And I don't know why... I'd hate to assume that people just want to bury a simple, fair solution to the problem without any justification.
You want to make market-making unprofitable and to turn the stock market into your town's real estate market. How easy is it to sell a house? What is an accurate price for your house? At this moment? To the dollar?
Real Estate isnt comparable. There are no market makers in real estate because the product isnt standardized and you can't make an equivalence market in one-off products... Houses aren't securities and the illusions propagated by securitizing the loans around them clearly has wild historical market risk attached.
"it is a sophomoric attempt at solving a human problem that simultaneously guts the actual mechanics of exchanges."
Markets are human constructs...the pure mechanics of exhanges aren't more important than the humans they serve. Fixing the human problems should be the priority, right?
There are lots of legitimate reasons for behavior that looks just like this. The problem is not one of technology, it is purely the intention that causes the problem.
Those canceled orders had to be listed, the bid-ask system had to transmit them, matching engines had to consider them, cancel machinery had to back them out, and price discovery is affected. Why shouldn't one pay for the costs incurred?
Finally, none of this has anything to do with spoofing, because spoofing doesn't need high cancel rates. If anything, making cancels more expensive will encourage the behavior, because it will make traditional market making more expensive (either explicitly or implicitly by requiring membership in a cartel to be a market maker). Meanwhile, the spoofers trade is much higher margin and can absorb the new extra cost more readily.
Deleted comment
Exact same end-results, but it eliminates the human "intent" that this law hinges on.
Is this whole controversy really that dumb? Yes.
Why are hackers and engineers so horrible at understanding trading, when they first get into it? If I had to name one reason - it's because they've been trained for their whole lives to assume that there is such a thing as a "real price". There is no "real price" for anything in the world. There is no one in the world that has some inside access to the mythical "real price".
At the surface level, both fields have many similarities, but unlike the engineering problems you've always dealt with, there is no clear undeniable truth that will be eventually uncovered with enough work. Assume that's true, now carefully consider the implications. If you can do that, you've crossed the most difficult mental gap when transitioning from engineering to trading.
To add complexity, it's not necessarily the case that someone who almost never trades is spoofing, or that they don't want to trade. Consider a simple strategy: I am willing to offer GE shares at 20.00 if the the wider index is trading at 100. In fact because there's some sort of relationship (real or imagined) I'm happy to sell as long as I get more than 1/5 of the index price for my GE shares. I'm also willing to buy on a similar ratio.
Now every time someone trades some other share, the index will move. And I will have to move my price.
The thing with spoofing is a spoofer doesn't want to trade. They just want to raise until everyone else folds. Just like in poker, it creates noise in the market. How exactly you prove that is hard to say.
Another thing, related to manipulation: you can move the market by actually trading as well. Especially if you're a big guy. I can't count the number of times (normally around expiry) when the index has moved unnaturally only to come right back. I think guys are getting done for this now, and it's about time.
Every professional trading operation uses such strategies to shift the book, the large banks and funds especially.
One guy? I feel like I am living in a fucking cartoon.
"He said he would “like to be able to alternate the closeness ie one price away or three prices away etc etc”, and needed “a facility to be able to enter multiple orders at different prices using one click” and a function that would cause his “order to be pulled if there are not x amount of orders beneath it”, according to the DoJ’s criminal complaint."
He also asked for a feature that would allow him to cancel on closeness, so if the market price started drift close to his buy/sell price he would cancel.
Now the interesting thing about thing about these features is that if you've ever worked at an investment bank, these features are not dissimilar from the kinds of requests you would get from trading desks.
For example, there are a number of algos out there that try to stay second on the order book. They may not cancel the order, but widening a spread is effectively the same thing.
As for a country with limitless resources hunting down an individual for playing the game and winning is farcical. They should be thanking him for highlighting how ludicrously vulnerable their market place is.
In other words, the prices everyone else offers do not change based on your purchase. They are based on an assessment of the company, not based on exactly how much you are willing to pay for stocks minus .01 cents.
(Yes there are gray areas, but as a principle it's valid.)
So for example you want to buy a million shares starting at $9.00 and this naturally moves the price up to $9.20 based on what everyone is offering. You're okay with that, but you are not okay with someone intercepting mid-purchase, buying a whole bunch of shares that were between $9.02 and $9.15, and instantly selling them back to you at $9.18.
Maybe I'm being too generous in my interpretation of "not moving the price", but this is the effect you get when you disguise your purchase. Only the actual demand affects the price. So I think that's what the real meaning is.
You see it as party A wants to trade with party B and party C steps into the middle of the transaction to extract money from the transaction that they have no right to.
What is in fact happening is that party A wants to trade with party B over and over again at the same price and party B wants to change their price based on these interactions.
The later is what is actually happening (in greatly simplified form) and it is the mechanic by which the market goes from $9.00 to $9.20.
Further, large block traders absolutely positively hate that it goes up no matter how it happens, because their whole trade is based on finding a market price inefficiency. The longer it remains, they longer they profit. If they could, they would make it a law that prices of transactions couldn't be shared.
This means the price smoothly curves up from $9.00 to $9.20, it doesn't instantly jump to $9.19 or $9.27 because B figures out how much A is willing to pay.
I'm not going to comment on how realistic such a principle is.
Party B is then inferring things about supply/demand patterns. He is not tracking a specific entity. Party A meanwhile is doing everything in his power to hide his large intentions (trading across multiple venues, with different executors, at different times, at different sizes, etc). This natural adversarial relationship is what causes the price to go from 9 to 9.20 and it does not instantly jump, it is smooth. This is the mechanic for how that smoothness occurs and happens in real life and needn't add any impossible principles to the mix for it to occur.
In either case, Party A is unhappy about it jumping. They want it at 9 for as long as they can charge it, and Party B wants to maximize the average price they can sell it at (that is it is better for them to continue selling at 9.18 than to scare everyone off at 9.20).
They break their orders into smaller pieces, and build (or rent from their brokers) algorithms to make their big orders harder to spot and less likely to move markets. John Arnold "spent millions of dollars developing a proprietary order-entry system to disguise and conceal strategies from external algorithms."
The "ideal" is that this would not be necessary. That this would provide no advantage, because markets would never try to spot "large intentions". Party B would not temporarily set a price that is less profitable for selling small numbers and more profitable for selling large numbers.
Markets don't need immediate higher-order feedback to be efficient.
And again, don't ask me how you would stop anyone.
If you have 10,000 shares that you want to sell, and you want to sell them all at a specific price, there is a simple mechanism to do that: enter a limit sell order.
If insider trading is legalized, the incentives are stacked even further towards intransparency in corporations, because it gives management yet another reason to try to hide what is going on. That will lead to more information being hidden on purpose. Sure, some of that information leaks back out via orders and price movements, but at least to me it seems overly optimistic to hope that the overall amount of publicly available information increases.
[0] http://www.wsj.com/articles/SB104786934891514900 (Paywall) [1] https://www.google.com/#q=%22the+case+for+insider+trading%22 (Google search results, top result)