Spoofing, sometimes called bluffing, is a market manipulation technique by which a stock, bond or futures trader places a large buy or sell order without intending to honor it. This action increases interest in the spoofed financial asset, driving its price upward.
Meanwhile, the trader takes advantage of artificially inflated prices to complete many smaller transactions before canceling the spoofed order. Section 747 of the Dodd-Frank Act of 2010 outlaws spoofing.
Common detection efforts
Regulators have the authority to monitor markets for spoofing and other illicit conduct. Among others detection efforts, the following red flags may encourage a market regulator to investigate:
- An abnormal number of cancelled orders in a trader’s book
- A history of cancelling orders soon after creating them
- A pattern of pre-execution order cancellations
- A comparatively larger percentage of cancelled orders than other traders
- Large, lopsided, layered or flashed orders in flat markets
A high burden of proof
While prosecutors have secured convictions under the Dodd-Frank anti-spoofing statute, doing so can be exceedingly difficult. To succeed with a criminal case, prosecutors must prove beyond a reasonable doubt a trader intended to illegally manipulate market prices.
During normal business, traders routinely place orders and later cancel them. While criminal intent may be one explanation for this type of behavior, there are legitimate reasons a trader may cancel a large order. For example, the priorities of the trader’s clients may simply change.
Because the burden of proof in spoofing cases is high, prosecutors should not confuse illegal activity with what is merely a sophisticated approach to trading.