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I don't get it. This guy's crime is placing offers with the intention of canceling them before they are executed. Why is this a crime, and what does it have to

I don't get it. This guy's crime is placing offers with the intention of canceling them before they are executed. Why is this a crime, and what does it have to do with the flash crash?

hmate9 10y ago
It is market manipulation. Placing a big order would signal to other traders that there is someone who wants to buy/sell a lot of the stock and therefore the stock's price would change accordingly. But then the trades are never actually executed, therefore he intentionally manipulated the price of the stock.
NDT 10y ago
He was manipulating the market by generating large sell orders. This would drop prices (because others can see that some stock is being rapidly sold off -- especially by high-frequency traders or other automated programs who will also start selling). He would then cancel these orders to buy at the new low prices. This is called spoofing orders. It was a large reason for the crash (though not the only component in my opinion) because these orders amounted to $200 million worth of bets that the market would fall and they were replaced or modified 19,000 times. And of course this is just one person. The market involves multiple people so you can imagine how much money was at stake here.
- jandrese 10y ago
  Of course investment banks do this sort of thing all of the time, this guy's crime is that he wasn't associated with one of the big incumbents. HFT generates and cancels orders on magnitudes like this all day long, but they have to be allowed to do so because it "creates markets", whatever that means.
  - gpderetta 10y ago
    > HFT generates and cancels orders on magnitudes like this all day long, but they have to be allowed to do so because it "creates markets", No, they are allowed because HFT firms have the intention to (and in fact, will gladly) trade.
    - jondubois 10y ago
      I don't think the intention matters if the result is the same.
      - gpderetta 10y ago
        it matters because the law says it matters.
      - kolbe 10y ago
        Well, the law doesn't really say anything beyond "manipulative devices" and "contrivances," but right now, judges have kinda ruled that intention matters. But we don't know much, because most of these cases get settled out of court, so we don't have a robust case law to base any of this off of. Basically, if you participate in a financial transaction in any way, be prepared to be accused of a crime.
      - lsadam0 10y ago
        The law strongly disagrees, and for good reason. See: manslaughter vs murder.
      - hermitdev 10y ago
        Intention mostly matters, sometimes doesn't. Sometimes the left arm doesn't talk to the right arm and conflicting orders go out. Technically this could be construed as spoofing, but sometimes it's business unit A not talking to business unit B, because A isn't in the same location as B, or there's a Chinese Firewall between A & B. It might not be intentional spoofing, but it can happen, anyway.
    - jandrese 10y ago
      Sort of true. They will do the trade, but only if there was already someone in the system willing to make the same trade. HFT firms don't hold positions at the end of the day.
      - eridius 10y ago
        AIUI, the difference is that, at the moment the HFTs place the order, they have every intention of filling them. Just because they might change their mind a fraction of a second later and modify their orders isn't particularly relevant. Whereas spoofing is placing orders that you don't have any intention of filling. The only point of the orders is to move the market, rather than to actually make trades. And that's the thing that's illegal.
- lawless123 10y ago
  Should it be illegal for s man to shout SELL! on a crowded trading floor?
  - wnevets 10y ago
    >on a crowded trading floor? does such a thing even exist anymore?
    - brianwawok 10y ago
      Yes just not for many products. You can tour it in Chicago.
  - twinkletwinkle 10y ago
    If he has no intention of selling, yes.
    - reddytowns 10y ago
      But he did. He just shouted, "nevermind," a few milliseconds later.
- rwmj 10y ago
  What happened if someone took him up on an order before it was cancelled?
  - elastic_church 10y ago
    He got some partial fills. And he had a separate account that would trade the market distortion. His big orders weren't the best bid or ask. They were a few orders deep in the market. Basically people and machines would jump further in front of the big buy or sell order with their own orders, and move the price in a direction. His smaller account would make profits from those trades. Yes you could affect trillions of dollars of derivatives and the sentiment of the entire market with just a few dozen millions. It is still a widespread practice and tough to prove. But spoofing was made illegal in the Dodd Frank Act. So if the government can nail some easy cases and create case law, then they could think about going after the banks that do it. Emphasis on think.
- jondubois 10y ago
  I also don't understand why this is illegal. The markets should not be predictable. People like that guy should be rewarded financially for making it unpredictable. You don't want to have an economy where only a tiny group of powerful people understand what's happening while 99.99999...% of the population are at in the dark and at their mercy. A fair system should be simple enough to be understood by everyone or complex enough to be understood by no one - Anything in-between is not a fair system.
  - eridius 10y ago
    > The markets should not be predictable. Uh, yeah they should. To someone with perfect knowledge, a proper free market should be 100% predictable. It's only unpredictable if other people know things that you don't (and the market itself is the vehicle by which that knowledge is disseminated). Introducing uncertainty into the market without introducing knowledge into the market is a bad thing. And spoofing trades in order to move the market isn't providing any knowledge, and it is in fact making the market less efficient because it no longer matches the knowledge of the participants.
    - kolbe 10y ago
      shouldn't a spoofer's action just be an opportunity for someone who has said knowledge to exploit the spoofter's enhanced liquidity?
      - eridius 10y ago
        Well, I'm not really sure how exactly to exploit this (I'm not a trader, all I really know about this is what I've read in all of the previous discussions about this), but that's really besides the point, because nobody has perfect information. In any case, I suspect the only real way to take advantage of this situation is to determine the orders that the spoofer actually does intend to make (e.g. spoofing to depress the price and then buying low) and making those trades first yourself. But you're not actually harming the spoofer in that case (except in that they didn't get to make the trade they wanted), because the spoofer won't actually have executed any trades, they'll have simply attempted (and failed) to execute them. Which is to say, if you have perfect knowledge, you might be able to prevent the spoofer from reaping the benefits of their spoofing, but you won't actually have harmed them, and of course the effect on the market is just as bad as if you let the spoofer spoof in peace.
gt2 10y ago
Honest questions from someone who is only slightly educated on market making: Is there a law that stated/states all trades need to be with real intention to buy? How can they prove that intention? Even if an indicator is actually having the amount of cash to finance the trades, that could be covered as well. Lastly, is it not the responsibility of the people receiving the trade orders to not let the new trade information out or do anything with that information themselves which would affect the market until the actual trade takes place?
- hellofunk 10y ago
  > Is there a law that stated/states all trades need to be with real intention to buy? We're not talking about trades, but rather the illusion of an intent to trade, when really there is no intent, and pushing that illusion onto the world to give the market the impression you will trade that amount, causing other market participants to react accordingly, which causes the market to move in the direction you wanted. Then you cancel your planned trade and profit off the move you manipulated. That's the gist of it, and yes there are laws against it.
  - csomar 10y ago
    You didn't answer the Parent Poster. He's asking how can the law determine if the trader was spoofing or legitimately trading. What are the criteria for that.
    - twinkletwinkle 10y ago
      Same way we decide everything, a sitting judge or a jury of your peers.
      - gt2 10y ago
        I know it's a common sentiment that "You can sue anyone for anything". But is it a common sentiment that you can be charged with anything by a district attorney?
digler999 10y ago
The game is only fair if you play to outsmart the other animals in the herd. Not if you actively harm them by misdirecting them with false signals.
TuringNYC 10y ago
Many hedge funds do the same thing. This guy's crime is doing it without being associated with the in-crowd.
- adventured 10y ago
  No they don't. The very big difference is intent and actual behavior. Sarao was blatantly not following through on any of his spoofing, which is where the intent is derived based on pattern of behavior. If a hedge fund behaved the exact same way, they'd get in trouble for it. That is, if Renaissance Technologies decided to do spoofing on 99.999% of its market action, they'd get in trouble for it. Hedge funds doing high frequency trading, is not the same as spoofing.
  - Retric 10y ago
    The SEC is fine with HFT traders executing less than 1/10th the orders they place so the rules are not that clear cut.
    - pgwhalen 10y ago
      Yes but canceling a lot of your orders is not necessarily indicative of spoofing. In fact it's kind of the crux of market making. These are ver different behaviors. https://www.bloomberg.com/view/articles/2015-10-08/why-do-high-frequency-traders-cancel-so-many-orders- https://www.bloomberg.com/view/articles/2015-10-08/why-do-hi...
brownegg 10y ago
Your question is exactly correct. As long as they are real orders, with real risk of being executed, there should be nothing at all wrong with this behavior. If people are so stupid as to move their orders trivially based on others' actions, they deserve what they get. The reason this gets prosecuted is that it's an easy target for the exchanges to make it look like they care. They are now publicly-traded companies interested in profits first and foremost--not market integrity (which maybe used to be the case--different discussion). source: 25-year vet of futures markets, the last 10 in HFT; many many millions of orders and executions
- digler999 10y ago
  > they deserve what they get. what about buy-and-hold investors who don't do anything to deserve that ? Why should they get unnecessary volatility in their portfolios just because some get-rich-quick kids want to treat NYSE like its Mortal Kombat? > if people are so stupid as to move their orders trivially based on others' actions Then why show level 2 quotes at all ? Isn't your argument equivalent to "level 2 information is useless"? If not, then people wouldn't be stupid for using it, would they ? Would you trade in a market that only had level 1 quotes ?
  - brownegg 10y ago
    They don't get unnecessary volatility unless they're paying attention to the order book all the time. Realized equity volatility is MUCH MUCH MUCH lower in the era of HFT. Yes, "flash crashes" exist, and normally because of liquidity disappearing. Yes, algos are basically sheep that all bail at the same time. But overall, the net effect is massively beneficial to everyone except lazy traders (which include fund managers who miss the days of getting lots of steak dinners from their favorite brokers).
    - digler999 10y ago
      I'm not arguing against algos or HFT, just spoofing. also I updated my comment to ask about level-2 quote information. If people are stupid for acting on perceived intention of other market participants, wouldn't that make the case that L2 quotes are entirely garbage and should just be removed from the exchange ?
pdovy 10y ago
Here's an analogous situation - let's suppose you are a buyer in an auction for a car. You're competing with all other interested buyers to get the car, and after a bunch of back and forth, you win the auction. Later, you find out that one of the most aggressive bidders in the auction was actually just a buddy of the seller, trying to increase the price in his/her favor but avoid at all costs actually winning the auction. You'd probably rightfully think this was unfair, and this is exactly what spoofers are doing in an electronic market. They are generating the illusion of interest to buy or sell, without the intention to actually do so, in order to move the market in their favor.
- oh_sigh 10y ago
  Why is that illegal? Why doesn't it just get you kicked from the market if you do it?
  - user5994461 10y ago
    It kicks you out of the market by sending you to prison.
  - mwfunk 10y ago
    Because it's financial fraud, and it harms the legitimacy of the market itself and it harms the other people participating in the market. It's not like banning a cheater in a video game, there are real world stakes.
    - oh_sigh 10y ago
      If video games have real world financial stakes(say, for professional eSports players like Dota/LoL), should cheating be punishable by jail time?
      - alasdair_ 10y ago
        Maybe. If we are playing poker, and you cheat, you have stolen my money through fraud. Certainly if I cheat at a casino, I'm likely going to jail.
jliptzin 10y ago
I was an intern at Goldman Sachs in 2007 working in IT and my boss was explaining to us how market making works and he described this exact phenomenon - how banks, hedge funds, HFT trading outfits spoof orders constantly so you cannot rely on the order book to determine direction / intent of other traders in the market. Apparently this guy's crime was not being part of a hedge fund or large bank.
- astanway 10y ago
  That isn't true. Making an order with an intent to cancel is a crime. Hedge funds routinely cancel orders, but they do not necessarily make them with the intent to cancel them from the beginning.
  - jliptzin 10y ago
    Insider trading is also a crime yet it is widespread on wall street, like snowflakes in a blizzard.
  - hermitdev 10y ago
    Perhaps the most routine trade I see is with a Time in Force of Immediate or Cancel. Fill or Partial Fill if you can, cancel the remainder. Happens millions of times a day.
  - raincom 10y ago
    Market makers have special privileges. That's why they abuse with spoofing, boxing, jumping, etc using offshore entities.

I don't get it. This guy's crime is placing offers with the intention of canceling them before they are executed. Why is this a crime, and what does it have to do with the flash crash?

hmate9 10y ago

It is market manipulation. Placing a big order would signal to other traders that there is someone who wants to buy/sell a lot of the stock and therefore the stock's price would change accordingly. But then the trades are never actually executed, therefore he intentionally manipulated the price of the stock.

NDT 10y ago

He was manipulating the market by generating large sell orders. This would drop prices (because others can see that some stock is being rapidly sold off -- especially by high-frequency traders or other automated programs who will also start selling). He would then cancel these orders to buy at the new low prices. This is called spoofing orders. It was a large reason for the crash (though not the only component in my opinion) because these orders amounted to $200 million worth of bets that the market would fall and they were replaced or modified 19,000 times. And of course this is just one person. The market involves multiple people so you can imagine how much money was at stake here.

jandrese 10y ago
Of course investment banks do this sort of thing all of the time, this guy's crime is that he wasn't associated with one of the big incumbents. HFT generates and cancels orders on magnitudes like this all day long, but they have to be allowed to do so because it "creates markets", whatever that means.
- gpderetta 10y ago
  > HFT generates and cancels orders on magnitudes like this all day long, but they have to be allowed to do so because it "creates markets", No, they are allowed because HFT firms have the intention to (and in fact, will gladly) trade.
  - jondubois 10y ago
    I don't think the intention matters if the result is the same.
    - gpderetta 10y ago
      it matters because the law says it matters.
    - kolbe 10y ago
      Well, the law doesn't really say anything beyond "manipulative devices" and "contrivances," but right now, judges have kinda ruled that intention matters. But we don't know much, because most of these cases get settled out of court, so we don't have a robust case law to base any of this off of. Basically, if you participate in a financial transaction in any way, be prepared to be accused of a crime.
    - lsadam0 10y ago
      The law strongly disagrees, and for good reason. See: manslaughter vs murder.
    - hermitdev 10y ago
      Intention mostly matters, sometimes doesn't. Sometimes the left arm doesn't talk to the right arm and conflicting orders go out. Technically this could be construed as spoofing, but sometimes it's business unit A not talking to business unit B, because A isn't in the same location as B, or there's a Chinese Firewall between A & B. It might not be intentional spoofing, but it can happen, anyway.
  - jandrese 10y ago
    Sort of true. They will do the trade, but only if there was already someone in the system willing to make the same trade. HFT firms don't hold positions at the end of the day.
    - eridius 10y ago
      AIUI, the difference is that, at the moment the HFTs place the order, they have every intention of filling them. Just because they might change their mind a fraction of a second later and modify their orders isn't particularly relevant. Whereas spoofing is placing orders that you don't have any intention of filling. The only point of the orders is to move the market, rather than to actually make trades. And that's the thing that's illegal.
lawless123 10y ago
Should it be illegal for s man to shout SELL! on a crowded trading floor?
- wnevets 10y ago
  >on a crowded trading floor? does such a thing even exist anymore?
  - brianwawok 10y ago
    Yes just not for many products. You can tour it in Chicago.
- twinkletwinkle 10y ago
  If he has no intention of selling, yes.
  - reddytowns 10y ago
    But he did. He just shouted, "nevermind," a few milliseconds later.
rwmj 10y ago
What happened if someone took him up on an order before it was cancelled?
- elastic_church 10y ago
  He got some partial fills. And he had a separate account that would trade the market distortion. His big orders weren't the best bid or ask. They were a few orders deep in the market. Basically people and machines would jump further in front of the big buy or sell order with their own orders, and move the price in a direction. His smaller account would make profits from those trades. Yes you could affect trillions of dollars of derivatives and the sentiment of the entire market with just a few dozen millions. It is still a widespread practice and tough to prove. But spoofing was made illegal in the Dodd Frank Act. So if the government can nail some easy cases and create case law, then they could think about going after the banks that do it. Emphasis on think.
jondubois 10y ago
I also don't understand why this is illegal. The markets should not be predictable. People like that guy should be rewarded financially for making it unpredictable. You don't want to have an economy where only a tiny group of powerful people understand what's happening while 99.99999...% of the population are at in the dark and at their mercy. A fair system should be simple enough to be understood by everyone or complex enough to be understood by no one - Anything in-between is not a fair system.
- eridius 10y ago
  > The markets should not be predictable. Uh, yeah they should. To someone with perfect knowledge, a proper free market should be 100% predictable. It's only unpredictable if other people know things that you don't (and the market itself is the vehicle by which that knowledge is disseminated). Introducing uncertainty into the market without introducing knowledge into the market is a bad thing. And spoofing trades in order to move the market isn't providing any knowledge, and it is in fact making the market less efficient because it no longer matches the knowledge of the participants.
  - kolbe 10y ago
    shouldn't a spoofer's action just be an opportunity for someone who has said knowledge to exploit the spoofter's enhanced liquidity?
    - eridius 10y ago
      Well, I'm not really sure how exactly to exploit this (I'm not a trader, all I really know about this is what I've read in all of the previous discussions about this), but that's really besides the point, because nobody has perfect information. In any case, I suspect the only real way to take advantage of this situation is to determine the orders that the spoofer actually does intend to make (e.g. spoofing to depress the price and then buying low) and making those trades first yourself. But you're not actually harming the spoofer in that case (except in that they didn't get to make the trade they wanted), because the spoofer won't actually have executed any trades, they'll have simply attempted (and failed) to execute them. Which is to say, if you have perfect knowledge, you might be able to prevent the spoofer from reaping the benefits of their spoofing, but you won't actually have harmed them, and of course the effect on the market is just as bad as if you let the spoofer spoof in peace.

gt2 10y ago

Honest questions from someone who is only slightly educated on market making: Is there a law that stated/states all trades need to be with real intention to buy? How can they prove that intention? Even if an indicator is actually having the amount of cash to finance the trades, that could be covered as well. Lastly, is it not the responsibility of the people receiving the trade orders to not let the new trade information out or do anything with that information themselves which would affect the market until the actual trade takes place?

hellofunk 10y ago
> Is there a law that stated/states all trades need to be with real intention to buy? We're not talking about trades, but rather the illusion of an intent to trade, when really there is no intent, and pushing that illusion onto the world to give the market the impression you will trade that amount, causing other market participants to react accordingly, which causes the market to move in the direction you wanted. Then you cancel your planned trade and profit off the move you manipulated. That's the gist of it, and yes there are laws against it.
- csomar 10y ago
  You didn't answer the Parent Poster. He's asking how can the law determine if the trader was spoofing or legitimately trading. What are the criteria for that.
  - twinkletwinkle 10y ago
    Same way we decide everything, a sitting judge or a jury of your peers.
    - gt2 10y ago
      I know it's a common sentiment that "You can sue anyone for anything". But is it a common sentiment that you can be charged with anything by a district attorney?

digler999 10y ago

The game is only fair if you play to outsmart the other animals in the herd. Not if you actively harm them by misdirecting them with false signals.

TuringNYC 10y ago

Many hedge funds do the same thing. This guy's crime is doing it without being associated with the in-crowd.

adventured 10y ago
No they don't. The very big difference is intent and actual behavior. Sarao was blatantly not following through on any of his spoofing, which is where the intent is derived based on pattern of behavior. If a hedge fund behaved the exact same way, they'd get in trouble for it. That is, if Renaissance Technologies decided to do spoofing on 99.999% of its market action, they'd get in trouble for it. Hedge funds doing high frequency trading, is not the same as spoofing.
- Retric 10y ago
  The SEC is fine with HFT traders executing less than 1/10th the orders they place so the rules are not that clear cut.
  - pgwhalen 10y ago
    Yes but canceling a lot of your orders is not necessarily indicative of spoofing. In fact it's kind of the crux of market making. These are ver different behaviors. https://www.bloomberg.com/view/articles/2015-10-08/why-do-high-frequency-traders-cancel-so-many-orders- https://www.bloomberg.com/view/articles/2015-10-08/why-do-hi...

brownegg 10y ago

Your question is exactly correct. As long as they are real orders, with real risk of being executed, there should be nothing at all wrong with this behavior. If people are so stupid as to move their orders trivially based on others' actions, they deserve what they get. The reason this gets prosecuted is that it's an easy target for the exchanges to make it look like they care. They are now publicly-traded companies interested in profits first and foremost--not market integrity (which maybe used to be the case--different discussion). source: 25-year vet of futures markets, the last 10 in HFT; many many millions of orders and executions

digler999 10y ago
> they deserve what they get. what about buy-and-hold investors who don't do anything to deserve that ? Why should they get unnecessary volatility in their portfolios just because some get-rich-quick kids want to treat NYSE like its Mortal Kombat? > if people are so stupid as to move their orders trivially based on others' actions Then why show level 2 quotes at all ? Isn't your argument equivalent to "level 2 information is useless"? If not, then people wouldn't be stupid for using it, would they ? Would you trade in a market that only had level 1 quotes ?
- brownegg 10y ago
  They don't get unnecessary volatility unless they're paying attention to the order book all the time. Realized equity volatility is MUCH MUCH MUCH lower in the era of HFT. Yes, "flash crashes" exist, and normally because of liquidity disappearing. Yes, algos are basically sheep that all bail at the same time. But overall, the net effect is massively beneficial to everyone except lazy traders (which include fund managers who miss the days of getting lots of steak dinners from their favorite brokers).
  - digler999 10y ago
    I'm not arguing against algos or HFT, just spoofing. also I updated my comment to ask about level-2 quote information. If people are stupid for acting on perceived intention of other market participants, wouldn't that make the case that L2 quotes are entirely garbage and should just be removed from the exchange ?

pdovy 10y ago

Here's an analogous situation - let's suppose you are a buyer in an auction for a car. You're competing with all other interested buyers to get the car, and after a bunch of back and forth, you win the auction. Later, you find out that one of the most aggressive bidders in the auction was actually just a buddy of the seller, trying to increase the price in his/her favor but avoid at all costs actually winning the auction. You'd probably rightfully think this was unfair, and this is exactly what spoofers are doing in an electronic market. They are generating the illusion of interest to buy or sell, without the intention to actually do so, in order to move the market in their favor.

oh_sigh 10y ago
Why is that illegal? Why doesn't it just get you kicked from the market if you do it?
- user5994461 10y ago
  It kicks you out of the market by sending you to prison.
- mwfunk 10y ago
  Because it's financial fraud, and it harms the legitimacy of the market itself and it harms the other people participating in the market. It's not like banning a cheater in a video game, there are real world stakes.
  - oh_sigh 10y ago
    If video games have real world financial stakes(say, for professional eSports players like Dota/LoL), should cheating be punishable by jail time?
    - alasdair_ 10y ago
      Maybe. If we are playing poker, and you cheat, you have stolen my money through fraud. Certainly if I cheat at a casino, I'm likely going to jail.

jliptzin 10y ago

I was an intern at Goldman Sachs in 2007 working in IT and my boss was explaining to us how market making works and he described this exact phenomenon - how banks, hedge funds, HFT trading outfits spoof orders constantly so you cannot rely on the order book to determine direction / intent of other traders in the market. Apparently this guy's crime was not being part of a hedge fund or large bank.

astanway 10y ago
That isn't true. Making an order with an intent to cancel is a crime. Hedge funds routinely cancel orders, but they do not necessarily make them with the intent to cancel them from the beginning.
- jliptzin 10y ago
  Insider trading is also a crime yet it is widespread on wall street, like snowflakes in a blizzard.
- hermitdev 10y ago
  Perhaps the most routine trade I see is with a Time in Force of Immediate or Cancel. Fill or Partial Fill if you can, cancel the remainder. Happens millions of times a day.
- raincom 10y ago
  Market makers have special privileges. That's why they abuse with spoofing, boxing, jumping, etc using offshore entities.