'Flash crash' trader's alleged fraud a common market occurrence
By John McCrank
NEW YORK (Reuters) - The market manipulation case against the British day trader U.S. authorities say helped spur the May 2010 "flash crash" may be the most high-profile to date, but the type of activity he is accused of is actually quite common, market participants say.
Navinder Singh Sarao was charged on Tuesday with allegedly using a computer trading program to generate large sell orders that pushed down prices. He then canceled those trades and bought the contracts at the lower prices, reaping a roughly $40 million profit on his trading, U.S. authorities said.
The practice, known as "spoofing," is difficult for regulators to detect because it can appear very similar to legitimate trading strategies, said Eric Noll, chief executive of agency broker Convergex in New York.
Brokers routinely use algorithms that place large volumes of orders at near light speed, hoping to hit advantageous prices, but then cancel the bulk of those orders when prices move. An average broker-dealer cancels between five and 30 orders for every trade completed, while electronic market makers may cancel closer to 100 trades per order completed, said Noll.
Broker-dealers cancel many more orders than they fill to provide their customers with the best possible price at the time the customer wishes to buy. If there's no customer demand for those orders, the broker-dealer cancels them.
Electronic market makers place large amounts of buy and sell orders to make it easier for traders to complete trades, profiting off the spread between the buy and sell price. If the price moves, market makers cancel the orders and make new ones to allow them to offer tight bid-ask spreads while still making a profit.
The difference is that a spoofer has no intention of completing the trades at the prices posted.
"The shady stuff goes on every day and at all hours where people put out big tickets without any intention of filling but with the intention of influencing the price up or down, a lot in crude oil," said Evan McDaniel, manager at IV Trading Group in Chicago, adding that enforcement appears to be selective. Continued...