Flash Spoofing, and "Normal" Market Operations

The criminal case filed by the DoJ against U.K. trader Navinder Sarao is the latest case to capture the media’s attention in what must be the early stages of a series of investigations into what we’ll broadly term “issues of market manipulation.”

 The potential for manipulative behavior has been garnering more attention over the past year since Michael Lewis’s “Flash Boys” more forcefully drew regulatory attention to issues around high frequency trading (HFT) activities and current market structures.

Regulators have received their fair share of criticism for taking nearly five years to investigate the Flash Crash, finally getting around to examining orders, and not just executions. 

While Mr. Flash Crash protests that he has “not done anything wrong apart from being good at my job,” regulators clearly have their sights on spoofing.  Just last week came news of the CFTC bringing civil charges against two prop traders in the UAE for allegedly spoofing in the gold and silver futures markets. All of this comes on the heels of several other low-profile players charged with spoofing over the past couple of years, such as Panther Trading. 

Spoofing, sometimes referred to as “hype & dump,” is basically when a trader enters orders with the sole purpose of influencing market prices and with no intention of actually executing those orders. 

Obviously the law does not require traders to openly state their intentions regarding whether they are buying or selling, and how much. Likewise, we don’t play poker with our cards face up. But what type of bluffing is kosher? To what lengths can one go to cloak his intentions so that others don’t run ahead, increasing transaction costs?

Kraft was recently hit with a CFTC complaint regarding its wheat futures trading, and this case seems to be more of a gray area.

But there's more to come, no doubt.

The general areas of interest concern front-running, spoofing, time advantages, and trading on insider information. Just a couple of weeks ago, we saw a situation which must fall smack in the middle of the realm of the regulatory whip: the Aussie dollar moved significantly just (milliseconds) before the announcement by the Reserve Bank of Australia (RBA). But even worse – this has now happened three consecutive times!

Let’s have a look at the overall movement, just before 3am, and then we’ll focus on the movement and its occurrence just before news came out.

Here's the movement, generally, at 00:30.

But the important note is the movement occurs just moments before (any) news is released.  See all the news items at the top?  Each news item corresponds to a blue box in the graph.

The first one, the rate decision, "flashes" into our screen, just AFTER the movement.

It's worth mentioning that we're not alone in discovering this market movement. The Australian Securities and Investment Commission is on top of things, having opened an investigation into these wild, yet accurate, swings.  Notices have purportedly "been sent to many financial institutions and platform providers to understand the basis of the trading on these markets at the point in time of interest." More troubling, however, is that preliminary findings have revealed to ASIC that:

"moves in the Australian Dollar ahead of the announcement to be as a result of normal market operations in an environment of lower liquidity immediately ahead of the RBA announcement. The reduction in liquidity providers is a usual occurrence prior to announcement in all markets. Much of the trading reviewed to date was linked to position unwinds by automated trading accounts linked to risk management logic and not misconduct." 

Call us skeptical (or sceptical, given they're in Australia).

One more likely explanation is that the news was leaked, or sold, to one or more firms that could execute quickly based on an incredibly fast network connection, likely linked to an algorithm. (If not, why wait for the seconds or milliseconds before the announcement – why not execute a minute before, or two minutes before?) 

So that opens up the door to the question of “time advantages” – more specifically, whether some preferred clientele can buy early access to the news. Let’s just say, it’s a little like gambling on a football game, in which most people are watching on tape-delay, but some gamblers are allowed to see the game “real-time.” The real-time gamblers can add or remove bets once the game is really finished, while the other gamblers with the lagged connection don’t yet know the final result. Can we call that a rigged market? 

The next legal question becomes: do the ordinary gamblers know that the preferred gamblers have a time advantage, or whether they know that they’re on a lagged connection (and that others are not). In other words, there’s the question of proper disclosure. Whether or not the market is rigged in favor of some parties, should the “unfavored” parties have been made aware of their material disadvantage?

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For more on Time Advantages in the Financial Markets, and corrective actions taking place, visit any of the following links:

The Crucial Piece of Information That Big Traders Get Before Everyone Else

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Thomson Reuters ends early access to key market data

Behind One Second of Trading Mayhem
(Article chronicles impact of earnings results released to paid clients milliseconds before news services released earnings, while those results impacted closing price of shares.)