Spoofing: Illegal Scheme to Drive Stock Prices Up or Down

Tips & TutorialsSpoofing: Illegal Scheme to Drive Stock Prices Up or Down

Spoofing: Illegal Scheme to Drive Stock Prices Up or Down

NASDAQ has started using a software that promises to eliminate spoofing from the stock and forex markets. SMART, the new surveillance software, is already up and running in 65 market places. According to the organization, SMART is not just another tool; it has been made by contributions from long serving market analysts; it does more than just “ticking the box”.
To enhance the new invention, NASDAQ is also considering situating cameras on all the marketing platforms under its influence. These will help in tracking of all irregularities reported.
But SMART doesn’t just report irregularities. It also analyzes its suspect list and gives suggestions on whether the case is worth following or not. This saves time and money.
On the day when Janet Yellen announced the Federal Reserve’s decision to raise interest rates in anticipation of a coming inflation, SMART reported over 500 possible frauds by midday.

The worrying trend

Since 2003, spoofing has risen at a disturbing rate. The illegal practice involves stockbrokers who exaggerate share prices with intent of gaining from the resulting panic of traders.

How spoofing is done

When broker A has shares of company B, whose bid price (the price at which B and other traders can buy each share at the moment) is lower than the ask price (the price at which B should sell each share at the moment), A decides to trick buyers (B included) that the share values are rising so that the other traders can buy the shares at a higher price.
Broker A can achieve this using one method: buying his or her own shares. Of course, he or she will go at a loss if the transaction is executed; so the way to avoid this is by canceling his own buying transactions when the closing time is nearing. By then, the other people will have already rushed to buy the “remaining” shares, and the person can walk away with millions of dollars in profit.
With the currently fast computing systems, the whole cycle of all these transactions take only a second or two. That is how volatile the stock market is; in one second, tens of businesses and individuals will be mourning over their losses, while a single firm or individual becomes a millionaire.

2010 flash crash

While flash crashes have been happening since time immemorial, the 2010 incident was the most widely reported. In a flash crash, exchange rates plummet then start shooting up immediately. This particular one spanned only around 36 minutes and resulted in huge losses as some of the highest valued shares were traded to as low as 1 penny each during the slump.
The situation was made worse by the fact that little human intervention was involved in the processes; computers executed most of the deals automatically.
Navinder Singh Sarao received major blame for the incident due to his spoofing of E-mini S&P 500 indices. He faced charges of 22 counts of fraud and manipulation by the US Department of Justice alone.
Some experts however argued in defense of Singh; prominent among them was John Bates of Traders Magazine, who compared the charges against Singh to laying blame on “lightning that has caused fire.”

Changing tactics

Before NASDAQ’s SMART was introduced, a lot of software had come and gone after proving inefficient, while a few are still in use for lack of a better choice.
Moreover, spoofers  are constantly changing their techniques and this has become even harder for the human analysts to identify them. Between 2014 and 2015, the number of stock market brokers engaging in these activities is thought to have increased past that of any other year before, yet the rate of reported and prosecuted cases does not reflect this.

The legal factor

While spoofing is now illegal in most jurisdictions, it is still proving difficult to bring wrongdoers to the book. Without proper legal interventions and solid international agreements in the near future, white collar crimes in stock market are bound to increase.
Sentiments by Morningstar analysts that the digital stock exchange market cannot continue being ruled by the laws of the depression era couldn’t be more appropriate for this moment. The 2010 Dodd-Frank Act has been criticized for being vague and for its seemingly selective enforcement. For instance, the concept of “intent”, on which this law relies, is quite abstract.
But there is also the fear factor; even if the best laws were formed to govern the American market, there is forex trade to deal with; the thought that US government can convince others to abide by its laws is far fetched. Moreover, firms might migrate to other countries to avoid such regulations.
A technology like SMART may be as good as its developers promise, but as long as the top guys do not find ways to match the law with the changing market atmosphere and the global environment, its future remains in the balance.