What is Spoofing Trading?

The financial markets are a competitive environment where everyone is looking for an edge. “Spoofing” is one technique some traders break the rules to their advantage.

Investors and traders should be wary of the stock market and exchange fraud known as spoofing. This strategy is occasionally applied to alter asset prices, whether they relate to forex, stocks, bonds, or cryptocurrency. Here are all the details you need to know about market manipulation and spoof trading, including how spoofing operates, its legal repercussions, and more.

Why Do People Spoof?

When traders issue market orders to purchase or sell assets and then cancel them before the order is ever filled, this is known as spoofing. It resembles the practice of issuing fictitious directives with no intention of ever having them carried out.

Spoofing is the practice of flooding the markets with orders in an effort to manipulate the price of securities.

What Purpose Does Spoofing Serve?

Market prices can be changed to one’s advantage because they are based on supply and demand; for example, the more in demand Stock A is, the higher its price is likely to go, and vice versa. This is where spoofing is useful.

Spoofers can affect securities prices by utilizing bots or an algorithm to conduct a large number of deals and then cancel them before they go through. Those valuations may have changed enough for a trader looking to buy or sell a specific security to make the trade more profitable.

By flooding the markets with orders, one can make it appear as though demand for a security is increasing or decreasing, which affects the asset’s price. Spoofers may use an algorithm to place and cancel orders instead of doing it by hand because it would take a great deal of “spoofed” orders to move valuations. Because of this, spoofing is frequently connected to high-frequency trading (HFT).

Is Spoofing Illegal?

It’s accurate to say that spoofing essentially involves gaming the system. Spoofing is against the law and is a crime in the United States. The Dodd-Frank Act, which was enacted into law in 2010, makes spoofing unlawful. Dodd-Frank section 747 amends section 4c(a) of the CEA to make it unlawful for any person to engage in any trading, practice, or conduct on or subject to the rules of a registered entity that—

  (A) violates bids or offers;

  (B) demonstrates intentional or reckless disregard for the orderly execution of transactions during the closing period; or

  (C) is, is of the character of, or is commonly known to the trade as ‘spoofing’ (bidding or offering with the intent to cancel the bid or offer before execution).”

The Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) both have legislation and regulations pertaining to spoofing.

Spoofing Example

It’s not hard to imagine a spoofing scenario in your head. For illustration, suppose John, a trader, wishes to sell 200,000 shares of Firm Y stock. In order to avoid spending any money, John employs an algorithm to place hundreds of “buy” orders for Firm Y shares. The program will also cancel these orders before they are completed.

The market interprets the surge in orders as a rise in demand for Firm Y shares, and the price starts to rise. After that, John sells his 200,000 shares at a premium price that was artificially inflated since he had actually manipulated the market to his advantage.

Repercussions of Spoofing

Although it is illegal, spoofing is a reasonably frequent activity for some traders and businesses since it is a simple technique to manipulate markets and maybe improve earnings. If and when they are discovered, spoofers may pay a price for their offense.

For instance, the SEC penalized JPMorgan Chase almost $1 billion in the fall of 2020 after the business was discovered engaging in precious metals market spoofing. The company was also under investigation by the CFTC and the US Department of Justice for illegal activities that took place in 2015 and 2016.

However, anyone can receive a beating from the authorities; it’s not just the prominent names. An solitary day trader was busted in August 2020 engaging in spoofing behavior, which resulted in earnings of about $140,000 for the trader. The CFTC eventually required the trader to pay a fine of more than $200,000.

Despite the high-profile incidents, spoofers are typically difficult to spot and apprehend. It is challenging to spot false market orders in real time when there are so many orders being submitted and executed at once (particularly with algorithmic or computer assistance).

What You Can Do to Prevent Spoofing

Many parties, whether it is through spoofing or other strategies, are persistently working to get an advantage in the markets. It is important for investors to keep this in mind and stick to a personal investing plan rather than letting their emotions or the news cycle influence their decisions.

Investors must comprehend what drives market activity in a time when a single tweet can send stock values skyrocketing or plunging.

Conclusion

Spoofing is prohibited and can carry severe consequences because it’s done to take advantage of the markets. Spoofing could have an impact on all investors in addition to the market manipulators. Traders and investors may respond if spoofers are manipulating prices for their personal gain without being aware of what is happening behind the scenes. Although this is more of a problem for day traders or active investors, it is still something to be aware of.