I have received many emails over the last several months from people who are wondering if I’ve changed my material so as to adapt to the new “anti-spoofing” rules. I felt a blog post was in order because there is a lot of misunderstanding about the effects of spoofing as well as what role it plays in a scalping methodology.
1. Spoofing = Placing an order with no intention of executing the order. The idea being that you are giving the illusion of size at certain prices and therefore, hopefully, inducing other traders to make trades based on that order.
2. Spoofing in and of itself does not have as much impact as people tend to believe. It causes temporary fluctuations simply because other traders (aka computers) then react to the order. But the real size is eventually always shown and the market moves to the price which the fundamentals dicate. A human is almost never fooled by a spoof. So basically, it’s computers trying to fool other computers and causing short-term movements as a result. Granted, HFT programs can cause massive volatility during crazy events but that is not due to spoofing. That’s lack of supervision and, funnily enough, a substantial lack of spoof orders.
To understand this better, I highly recommend this article. This guy nails it.
3. Spoofing is but one piece of a very large puzzle and any good methodology is always looking at the puzzle as a whole. Spoofing has its place, to be sure, and it can offer clues to short-term direction and profitable setups but it’s only one part of the equation. There is more value in watching the actual amounts which are trading at each price and in noticing how the market is reacting to that volume. Spoofing has been blown out of proportion mainly due to the media and other traders who have lost money as a result of their computers being outsmarted. A lot of emphasis is placed on it as a “bad thing” but it’s not nearly as important as the media would have you believe. This is why I teach people how to identify spoofing but I also show them how you have to incorporate that information into the big picture. Context is key. As always.
4. If spoofing completely disappeared, it would most likely be easier to trade a solid scalping methodology. I cut my teeth in the very early days of electronic trading in the treasury markets and there was much less spoofing then than there is now. And it was easier to trade. So everything I teach applies. With or without spoofing. If it did disappear, the only change in my material would be to say, “This setup doesn’t exist anymore because spoofing doesn’t exist anymore. Moving along to the next setup…”
5. As it stands, I’ve noticed little if any difference in the amount of spoofing since the regulation was passed. It is still happening every day. And it’s obvious. And you don’t see anyone getting charged with violations. I think people may be doing it a little less frequently and with less size showing because they know that prying eyes are watching but traders who spoof also tend to do a lot of volume and the exchanges do not want to lose that volume so a lot of heads are still going to look the other way. There may be a gradual change in the volume over time but that will probably only happen if a very large number of prosecutions and convictions begin to take place.
6. The Panther Energy trial was, in my mind, nothing more than the regulators trying to justify their jobs. They had to find a sacrificial lamb and Coscia made his actions extraordinarily obvious in a very thin market. He was stupid about it but he also probably didn’t think he was doing anything wrong. Spoofing has been around forever in some form or another. Traders in the pit would spoof. They dropped their hands all the time. Or a big floor trader may have been acting like he wanted to get filled a price or two off the inside market while simultaneously having a broker or several brokers work orders for him on the opposing side of the market. Once they filled his orders on that side, he dropped his hands. Order no longer there. Why is the big man dropping his hands? Other pit guys move the market in his favor without even realizing they had just filled him on the other side two minutes ago.
And treasuries in particular offer an unusual dilemma. In reality, prosecuting the major players who use spoof orders in the treasury markets would mean prosecuting the firms who, on average, comprise anywhere from 20% to 60% of the daily volume. Somehow I do not see that happening anytime soon if ever.
7. If you read up on the Panther Energy trial, you will see just how difficult it is to get a conviction on this. Coscia’s program (which, by the way, he didn’t even program) apparently placed spoof orders hundreds or perhaps even thousands of times but yet the prosecution had to narrow it down to just a few very obvious instances for fear that they would lose the jury’s attention while trying to explain the situation.
Try to imagine having this conversation with a jury.
Prosecution – “So you see, he used this program to place orders which he had no intention of executing.”
Jury – “Well the order was there. If someone hit it, it would have been filled, right?”
Prosecution – “Well, yes, but it was never going to be filled. He would pull it too fast.”
Jury – “How can he pull it too fast if someone hits it?”
Prosecution – “No, no. It was off the inside market and simply there to trick other traders. The odds of it getting hit were slim to none.”
Jury – “But it was possible?”
Prosecution – “Yes. But not likely.”
Jury – “So he can’t change his mind? What if I have an order to buy Apple and then they have poor earnings and I cancel my order. Is that illegal?”
Prosecution – “Of course not. This is different. He had already determined not to trade before placing the order.”
Jury – “Did you say that these orders were placed by his computer while he was sleeping?”
Prosecution – “Some of them.”
Jury – “And the trades which did get filled were matched against other computer generated orders which were trading while their programmers were sleeping?”
Prosecution – “Well, probably. But that’s not the point.”
Jury – “So his computer just outsmarted the other computers for a couple ticks? I don’t see how this can be a criminal act. The traders on the other side of these trades who are working their own programs didn’t have to trade. They chose to trade because they also wanted to make money and thought they could outsmart his computer. Would they be on trial if they had made money and he had lost it?”
Prosecution – “You’re getting off topic. You see, he wasn’t offering any value to the market.”
Jury – “I’m pretty sure my 100 shares of Apple doesn’t offer any value to the market. I just want to make a few dollars. Isn’t that trading?
Prosecution – “But you see…the regulation says…”
Jury – “Was he trading on inside information or using false news to try and manipulate the price.”
Prosecution – “No. But you’re missing the point. His practice was disrupting the integrity of the marketplace.”
Jury – “By faking out other computers and not substantially affecting the price in any fundamental way over the long term?”
Prosecution – “Well…yes.”
Jury – “…….I don’t see the problem here.”