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My (limited) understanding is that almost all high frequency hedge funds employ this tactic of placing and cancelling limit orders. Not sure why this guy is bei

by bko 12y ago

My (limited) understanding is that almost all high frequency hedge funds employ this tactic of placing and cancelling limit orders. Not sure why this guy is being prosecuted. > We investigate the trading of one hundred Nasdaq-listed stocks on INET, a limit order book. In contrast to the usual view, we find that over one-third of nonmarketable limit orders are cancelled within two seconds [0] When so many participants and breaking the law and the law seems to be applied somewhat subjectively, then it is ripe for corruption and political targetting. Kind of like how political dissidents get arrested for 'tax evasion' in Russia To be fair, this study was performed in 2007 and spoofing became explicitly illegal under Dodd Frank passed in 2010. I mentioned this in a comment in an earlier reply, but I think some skepticism around market participants is healthy. If market participants assume that there is no fraud or that fraud will be prosecuted by central authorities, they will be more easily defrauded. Edit: Looks like the number of unfilled orders is over 90% > New data from the US Securities and Exchange Commission (SEC) show that only 3.2% of the orders placed in the stock market in the second quarter of 2013 actually went through. [1] [0] http://papers.ssrn.com/sol3/papers.cfm?abstract_id=994369 http://papers.ssrn.com/sol3/papers.cfm?abstract_id=994369 [1] http://qz.com/133695/96-8-of-trades-placed-in-the-us-stock-market-are-cancelled/ http://qz.com/133695/96-8-of-trades-placed-in-the-us-stock-m...

cma 12y ago
You are right that most place and cancel orders rapidly, but that isn't necessarily spoofing, which requires some intentionality. For example, Nasdaq even has an order type that auto-adjusts itself such that it will never execute, but it was mainly created to help market-makers dodge quoting requirements, not to enable spoofing. In symbols where they are a registered market-maker, market-makers are supposed to be obligated to make a market in the symbol. In exchange they get several regulatory benefits, like being able to naked short a stock (sell it without even locating/borrowing the shares). In practice most automated market-makers used to just put out bogus quotes they never expected to fill at $0.1/$1000000.0 bid/ask. The SEC tried to regulate this and say you had to really be making a market and put your quotes within X% of the current bid/ask. Market-makers started automatically cancelling and replacing at exactly X% away, but that was too much for them. So they had Nasdaq create an order type that automatically cancels itself and replaces it X% away from the bid/ask anytime the NBBO changes. What they are doing in that example is completely wrong, but not analogous to what the guy in this article was allegedly doing (this guy put his quotes near the money to make fake interest, market-makers put theirs as far away from the money as possible to be fake market-makers and get regulatory benefits like naked shorting in exchange, their orders don't appear like real buy/sell interest in the same way this guy's allegedly did). --- The author of the article tries to distance algorithmic-HFT from this guy operated, to cleanse its name, but come one: Sarao may have been a spoofer, but he doesn't seem to have been doing the sort of high-speed algorithmic trading that usually qualifies as "HFT." He himself claimed to be "'an old school point and click prop trader' who had 'always been good with reflexes and doing things quick,'" and the "Layering Algorithm" that he used was a customized version of "a program that allowed non-programmers to engage in automated trading using spreadsheet commands and functions." He was also the sole owner and employee of his trading firm, which he "operated from his residence." In style and substance he is not all that different from other spoofers we have known and loved, who did their high speed trading by just punching keys really fast. In style and point-and-click background maybe he wasn't a goliath HFT operation, but in substance, spreadsheet automated trading at faster than human speeds, he definitely was. -- If the charges hold up, they will have been able to convict this guy because of evidence of intentionality (the emails to his FCM). But with trading strategies now starting to delve into modern deep-learning techniques, we're probably going to start seeing algorithms learn to spoof from a blank slate. The only way to tell if one of these algorithms is really intending to buy or sell or is spoofing would be to reverse engineer something rather inscrutable... And is it the author's intentionality or the algorithm's we're really concerned with? Likely we'll end up holding things to some gamable metrics that will do about as good a job as the market-maker quoting requirements do in assuring market-maker algorithms are providing liquidity.
- ikeboy 12y ago
  Wouldn't that be illegal under Dodd-Frank then?
- bko 12y ago
  Do you know the name of that type of order?
  - DeanWormer 12y ago
    He's probably referring to a Market Maker Pegged Order.
    - justonepost 12y ago
      Thanks! Love HN.
- devinhelton 12y ago
  It seems like the real fix would be to have a cancellation fee. If an order is canceled within 60 seconds, penalize the trader .1% of the total amount of the order. That would make all this gamesmanship unprofitable, and the order book would actually be a collection of people wanting to buy and sell shares. It seems very wrong to me to make an activity feasible, and allow it to be profitable, but then arbitrarily drop the hammer of criminal penalties when a trader crosses some murky line.
  - pas 12y ago
    There already is. If you add liquidity you get a bit of a bonus, if you remove it (cancel your limit order), you are charged a small amount. Why are people so fixated on the order book? The real information is the spot price and how fresh is that information (and the volume), the order book is a fantasy anyhow. There are people willing to buy stuff at pennies always, and sell at thousands. How does that help you? What if they cancel? It shouldn't matter if someone does it closer to the spot price, or closer to the best bid-offer. If you want to buy, look at the price, decide how much you think it's worth, put in a limit order at that price. Go to bed. If you want to sell, basically do the same. If you want to live on trading, then smarten up.
evanpw 12y ago
It is legal to change your mind quickly. It is illegal to place an order with the intention to cancel it before it executes.
- glesica 12y ago
  Which makes the law entirely unenforceable unless the perpetrator is dumb / arrogant / ignorant enough to brag about it...
  - johntb86 12y ago
    But these are high-frequency trades, which mean that they're executed by a computer programmed to do that. If you can examine exactly what it was programmed to do then that could probably help prove intent.
    - cma 12y ago
      "You're honor, it wasn't me, it just deep-learned it that way." If a program uses AI to come up with strategies, how do you make sure it doesn't learn to spoof? Coming up with the goal-formulation of "don't spoof" seems like it would require the program to introspect about its own intent. Dunno, I would like to hear what kind of metrics one would use to make the learning algorithm reject spoofing strategies. I guess it would be something similar to whatever heuristics the SEC uses to flag potential spoofing, but they get a lot of false positives and almost never convict someone on metrics.
- Dylan16807 12y ago
  But what does "intention to cancel" mean when you're offering to sell stock at an above-market price? What if I'm perfectly happy letting someone buy that stock from me because I can replace it at a lower price once the market settles? I'm still trying to manipulate the market prices, but am I "spoofing"?
  - evanpw 12y ago
    If you're actually willing to trade at that above-market price if the market moves suddenly, then that's a legitimate strategy and not manipulation. You're playing the role of a shock-absorber. If your plan is to cancel as quickly as possible if you see the market moving toward you, then that's illegal.
Nursie 12y ago
>> Not sure why this guy is being prosecuted. It's traditional to praise the big finance houses when they pull this stuff, but for individuals it's a crime, because they found a way to 'cheat' the big boys. Here's another example - http://www.computerworlduk.com/news/security/3244186/norwegian-traders-convicted-for-outsmarting-us-stock-broker-algorithm/ http://www.computerworlduk.com/news/security/3244186/norwegi...
- tptacek 12y ago
  Could you find the most specific example you can of a large investment bank (or equivalent firm) being praised for manipulating the market? Specific enough that we can actually dig into what specifically they're being praised for doing?
  - shit_parade2 12y ago
    Any central bank since 2008.
  - deleted 12y ago
    [deleted]
- adamiscool 12y ago
  Wow, that case in contrast to the current one actually seems absurd. Upon further research though they were cleared of any wrongdoing on appeal in 2012 [1] [1] http://www.ft.com/intl/cms/s/0/e2f6d1cc-9447-11e1-bb47-00144feab49a.html#axzz3Y3kHC5Wk http://www.ft.com/intl/cms/s/0/e2f6d1cc-9447-11e1-bb47-00144...
yummyfajitas 12y ago
HFTs place and cancel orders with the goal of getting fills. They rapidly place and cancel orders with the goal of getting fills at the best price. They also engage in all sorts of other practices (e.g., buying order flow) designed to get more fills. I.e., if the nbbo for SYMB is $10.00/10.10, an HFT might place an order at $10.01, then a bunch more pile on. Then the market moves down and the HFT cancels the $10.01 order and puts in another one at $9.95, in the hope that SYMB will move down to meet him. The goal is to get a fill from an uninformed (i.e. small) trader. In contrast, this guy was deliberately avoiding fills, and more importantly, sent an email proving this was his goal. (That latter part is very important when the illegality of a specific action varies depending on what your goal is.)
- T-zex 12y ago
  My understanding is that this guy did exactly the same thing you've described a HFT would do. The intention of $10.01 is to move a price, not to get a fill.
  - tptacek 12y ago
    No, the intention of 10.01 is to capture the fill when the market goes there. The intention of a spoofer is to induce the market to go somewhere it shouldn't, jump the hell out of the way so as not to fill at that bad price, and then profit from the correction back to the right price.
justonepost 12y ago
> Not sure why this guy is being prosecuted. You have to start somewhere / make an example of someone. Lone wolves trading from their houses have fewest friends and are easiest targets. Hopefully they go after bigger fish as well.
- shit_parade2 12y ago
  Compete fantasy. Eric Holder is on record stating he did not pursue criminal charges against large financials because of systemic risk. One law for some, another for everyone else.
tptacek 12y ago
The job of a market maker is to ensure that there is always a counterparty for buyers and sellers; an MM takes a chaotic marketplace and, for those who need it, presents the illusion that (for instance) you can buy a security the same way you buy a book on Amazon: here's a price, click buy, done. If you try to think about it, it's hard to get your head around how MMs can provide this service. Ensure a counterparty to buy from, or sell to? The market is constantly moving. From where do they get the superpower of always having stuff to sell, or always being able to buy? How are they not taking a bath doing this? One reason MMs can exist is because they charge a premium and pay a discounted rate for the securities they charge. The premium you pay an MM when you buy a security offsets the risk that they're getting the fuzzy end of the lollipop, which, if it happened over and over again, would force the MM out of business. But: it's tricky to charge a premium (or pay a discount) against an estimated fair market value that is constantly changing. Also: the size of the premium/discount (the spread) depends on factors that also constantly change. For me, knowing these things makes it intuitively obvious why MMs need to constantly submit and cancel new orders. It's like the edits in a simple diff algorithm; cancellations are the "-" lines, order entries are "+" lines, and a "change" in an order requires both.
- mmastrac 12y ago
  "the fuzzy end of the lollipop"? I can guess the context, but I have absolutely no idea what that analogy means. EDIT: http://www.urbandictionary.com/define.php?term=fuzzy+end+of+the+lollipop http://www.urbandictionary.com/define.php?term=fuzzy+end+of+...

by bko 12y ago

cma 12y ago

You are right that most place and cancel orders rapidly, but that isn't necessarily spoofing, which requires some intentionality. For example, Nasdaq even has an order type that auto-adjusts itself such that it will never execute, but it was mainly created to help market-makers dodge quoting requirements, not to enable spoofing. In symbols where they are a registered market-maker, market-makers are supposed to be obligated to make a market in the symbol. In exchange they get several regulatory benefits, like being able to naked short a stock (sell it without even locating/borrowing the shares). In practice most automated market-makers used to just put out bogus quotes they never expected to fill at $0.1/$1000000.0 bid/ask. The SEC tried to regulate this and say you had to really be making a market and put your quotes within X% of the current bid/ask. Market-makers started automatically cancelling and replacing at exactly X% away, but that was too much for them. So they had Nasdaq create an order type that automatically cancels itself and replaces it X% away from the bid/ask anytime the NBBO changes. What they are doing in that example is completely wrong, but not analogous to what the guy in this article was allegedly doing (this guy put his quotes near the money to make fake interest, market-makers put theirs as far away from the money as possible to be fake market-makers and get regulatory benefits like naked shorting in exchange, their orders don't appear like real buy/sell interest in the same way this guy's allegedly did). --- The author of the article tries to distance algorithmic-HFT from this guy operated, to cleanse its name, but come one: Sarao may have been a spoofer, but he doesn't seem to have been doing the sort of high-speed algorithmic trading that usually qualifies as "HFT." He himself claimed to be "'an old school point and click prop trader' who had 'always been good with reflexes and doing things quick,'" and the "Layering Algorithm" that he used was a customized version of "a program that allowed non-programmers to engage in automated trading using spreadsheet commands and functions." He was also the sole owner and employee of his trading firm, which he "operated from his residence." In style and substance he is not all that different from other spoofers we have known and loved, who did their high speed trading by just punching keys really fast. In style and point-and-click background maybe he wasn't a goliath HFT operation, but in substance, spreadsheet automated trading at faster than human speeds, he definitely was. -- If the charges hold up, they will have been able to convict this guy because of evidence of intentionality (the emails to his FCM). But with trading strategies now starting to delve into modern deep-learning techniques, we're probably going to start seeing algorithms learn to spoof from a blank slate. The only way to tell if one of these algorithms is really intending to buy or sell or is spoofing would be to reverse engineer something rather inscrutable... And is it the author's intentionality or the algorithm's we're really concerned with? Likely we'll end up holding things to some gamable metrics that will do about as good a job as the market-maker quoting requirements do in assuring market-maker algorithms are providing liquidity.

ikeboy 12y ago
Wouldn't that be illegal under Dodd-Frank then?
bko 12y ago
Do you know the name of that type of order?
- DeanWormer 12y ago
  He's probably referring to a Market Maker Pegged Order.
  - justonepost 12y ago
    Thanks! Love HN.
devinhelton 12y ago
It seems like the real fix would be to have a cancellation fee. If an order is canceled within 60 seconds, penalize the trader .1% of the total amount of the order. That would make all this gamesmanship unprofitable, and the order book would actually be a collection of people wanting to buy and sell shares. It seems very wrong to me to make an activity feasible, and allow it to be profitable, but then arbitrarily drop the hammer of criminal penalties when a trader crosses some murky line.
- pas 12y ago
  There already is. If you add liquidity you get a bit of a bonus, if you remove it (cancel your limit order), you are charged a small amount. Why are people so fixated on the order book? The real information is the spot price and how fresh is that information (and the volume), the order book is a fantasy anyhow. There are people willing to buy stuff at pennies always, and sell at thousands. How does that help you? What if they cancel? It shouldn't matter if someone does it closer to the spot price, or closer to the best bid-offer. If you want to buy, look at the price, decide how much you think it's worth, put in a limit order at that price. Go to bed. If you want to sell, basically do the same. If you want to live on trading, then smarten up.

evanpw 12y ago

It is legal to change your mind quickly. It is illegal to place an order with the intention to cancel it before it executes.

glesica 12y ago
Which makes the law entirely unenforceable unless the perpetrator is dumb / arrogant / ignorant enough to brag about it...
- johntb86 12y ago
  But these are high-frequency trades, which mean that they're executed by a computer programmed to do that. If you can examine exactly what it was programmed to do then that could probably help prove intent.
  - cma 12y ago
    "You're honor, it wasn't me, it just deep-learned it that way." If a program uses AI to come up with strategies, how do you make sure it doesn't learn to spoof? Coming up with the goal-formulation of "don't spoof" seems like it would require the program to introspect about its own intent. Dunno, I would like to hear what kind of metrics one would use to make the learning algorithm reject spoofing strategies. I guess it would be something similar to whatever heuristics the SEC uses to flag potential spoofing, but they get a lot of false positives and almost never convict someone on metrics.
Dylan16807 12y ago
But what does "intention to cancel" mean when you're offering to sell stock at an above-market price? What if I'm perfectly happy letting someone buy that stock from me because I can replace it at a lower price once the market settles? I'm still trying to manipulate the market prices, but am I "spoofing"?
- evanpw 12y ago
  If you're actually willing to trade at that above-market price if the market moves suddenly, then that's a legitimate strategy and not manipulation. You're playing the role of a shock-absorber. If your plan is to cancel as quickly as possible if you see the market moving toward you, then that's illegal.

Nursie 12y ago

>> Not sure why this guy is being prosecuted. It's traditional to praise the big finance houses when they pull this stuff, but for individuals it's a crime, because they found a way to 'cheat' the big boys. Here's another example - http://www.computerworlduk.com/news/security/3244186/norwegian-traders-convicted-for-outsmarting-us-stock-broker-algorithm/ http://www.computerworlduk.com/news/security/3244186/norwegi...

tptacek 12y ago
Could you find the most specific example you can of a large investment bank (or equivalent firm) being praised for manipulating the market? Specific enough that we can actually dig into what specifically they're being praised for doing?
- shit_parade2 12y ago
  Any central bank since 2008.
- deleted 12y ago
  [deleted]
adamiscool 12y ago
Wow, that case in contrast to the current one actually seems absurd. Upon further research though they were cleared of any wrongdoing on appeal in 2012 [1] [1] http://www.ft.com/intl/cms/s/0/e2f6d1cc-9447-11e1-bb47-00144feab49a.html#axzz3Y3kHC5Wk http://www.ft.com/intl/cms/s/0/e2f6d1cc-9447-11e1-bb47-00144...

yummyfajitas 12y ago

HFTs place and cancel orders with the goal of getting fills. They rapidly place and cancel orders with the goal of getting fills at the best price. They also engage in all sorts of other practices (e.g., buying order flow) designed to get more fills. I.e., if the nbbo for SYMB is $10.00/10.10, an HFT might place an order at $10.01, then a bunch more pile on. Then the market moves down and the HFT cancels the $10.01 order and puts in another one at $9.95, in the hope that SYMB will move down to meet him. The goal is to get a fill from an uninformed (i.e. small) trader. In contrast, this guy was deliberately avoiding fills, and more importantly, sent an email proving this was his goal. (That latter part is very important when the illegality of a specific action varies depending on what your goal is.)

T-zex 12y ago
My understanding is that this guy did exactly the same thing you've described a HFT would do. The intention of $10.01 is to move a price, not to get a fill.
- tptacek 12y ago
  No, the intention of 10.01 is to capture the fill when the market goes there. The intention of a spoofer is to induce the market to go somewhere it shouldn't, jump the hell out of the way so as not to fill at that bad price, and then profit from the correction back to the right price.

justonepost 12y ago

> Not sure why this guy is being prosecuted. You have to start somewhere / make an example of someone. Lone wolves trading from their houses have fewest friends and are easiest targets. Hopefully they go after bigger fish as well.

shit_parade2 12y ago
Compete fantasy. Eric Holder is on record stating he did not pursue criminal charges against large financials because of systemic risk. One law for some, another for everyone else.

tptacek 12y ago

The job of a market maker is to ensure that there is always a counterparty for buyers and sellers; an MM takes a chaotic marketplace and, for those who need it, presents the illusion that (for instance) you can buy a security the same way you buy a book on Amazon: here's a price, click buy, done. If you try to think about it, it's hard to get your head around how MMs can provide this service. Ensure a counterparty to buy from, or sell to? The market is constantly moving. From where do they get the superpower of always having stuff to sell, or always being able to buy? How are they not taking a bath doing this? One reason MMs can exist is because they charge a premium and pay a discounted rate for the securities they charge. The premium you pay an MM when you buy a security offsets the risk that they're getting the fuzzy end of the lollipop, which, if it happened over and over again, would force the MM out of business. But: it's tricky to charge a premium (or pay a discount) against an estimated fair market value that is constantly changing. Also: the size of the premium/discount (the spread) depends on factors that also constantly change. For me, knowing these things makes it intuitively obvious why MMs need to constantly submit and cancel new orders. It's like the edits in a simple diff algorithm; cancellations are the "-" lines, order entries are "+" lines, and a "change" in an order requires both.

mmastrac 12y ago
"the fuzzy end of the lollipop"? I can guess the context, but I have absolutely no idea what that analogy means. EDIT: http://www.urbandictionary.com/define.php?term=fuzzy+end+of+the+lollipop http://www.urbandictionary.com/define.php?term=fuzzy+end+of+...