Overview

Spoofing is a disruptive algorithmic trading 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,^([jargon]) 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 algorithms and front-running, activities which are also illegal.

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 After the genuine order trades, the multiple orders on the other side are rapidly withdrawn."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 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 (CFTC) and Britain's Financial Conduct Authority (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. 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, Nasdaq, Better Alternative Trading System (Bats) — an electronic communication network (ECN) – 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. 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 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.