It is clear that HFTs are doing their best to make their order front running algos more profitable by trying to eliminate spoofing. They are using the CFTC, HFT loving exchanges, and the ignorant public to do this. Spoofers are now considered evil, deceptive, and bad for the markets, and even blamed for the flash crash (LOL). Spoofing is not a free lunch, those are real live orders that can get clipped by an aggressive buyer/seller and lose big on a trade. They are not off limits. But spoofers usually don't get clipped and do make it harder to judge market intentions by just looking at changes in the DOM order book. The spoofers make it more costly for HFTs to front run orders entered because many more orders are false tells and front running algos end up paying the spread often for no edge. Thus making them less likely to front run orders. It is a cat and mouse game. Now the cat(front running HFTs) is playing with a mouse(spoofers and institutional traders) with its legs cut off. The cat becomes fatter since it knows that almost every order now is not coming from a spoofer, but from a trader showing his real intentions. It is like getting rid of the bluff in poker. Now almost everytime someone bets, the HFTs know that they have the goods and the order is real. It makes it much easier for HFTs to skim off profits from order flow, because now they are rarely faked out. Front runners are the parasites of institutional traders/ fund managers because they are so skilled at recognizing market intentions from changes in the order book, and getting in front of it, increasing slippage for big orders. John Arnold, the billionaire ex hedge fund manager/genius put up an interesting article on the spoofers versus front runners. http://www.bloombergview.com/articles/2015-01-23/high-frequency-trading-spoofers-and-front-running
@MarketOwl , you may have a point. I'm not at all in favor of spoofing, but if you define this kind of pattern as intentionally sending orders you never intend to execute, then one look at the ES order book should confirm that spoofing isn't the only example of people sending orders they don't intend to trade. If a trader is intentionally sending large orders that he doesn't intend to execute in an effort to move the market, that's not fair, especially if said trader goes to lengths to prevent himself from getting filled like cancellations and intentionally moving to the back of the queue as the now infamous Sarao seems to have been intending to do. I have trouble indicting HFTs for front running. Profitable trading is front running. A lot of the HFT game is about queue position. Layering the book and then trying to screw with people layering/shaping the book. For example, when you try to layer on ES, you'll often see that someone will immediately join the queue behind you with size. My guess is that this group of traders probably know that they can cancel much more quickly and are trying to get you to leave your order in the book by putting you under the false pretense that there is a lot of interest behind you in the the queue that will hold up long enough to capture the spread. They can cancel at the last moment and then price potentially gaps because it doesn't take much orderflow to blow through what's left of the queue. I have no evidence supporting that this is what they're actually aiming to do, but this is just one example of another potentially deceptive practice. In speaking with HFTs/job interviews, none that I've met seem to be too interested in deceptive practices. Of course, I doubt they'd tell me if they were, but most seem somewhat morally opposed to manipulation and would prefer to just restrict most of their orders to quoting en masse to try to capture the spread in a straight up liquidity provision fashion. They aren't necessarily even hunting for large orders, it's just that knowing about large orders make it easier to predict order flow. I just don't think I'll buy an argument that spoofing could improve market quality, but I do appreciate your point.
If the HFTs weren't hunting for large orders, then spoofing would be totally ineffective. Obviously the fact that HFTs react to new orders showing up on the order book means that their algos factor in large changes in bid and ask size into their buy/sell decisions. The reason you see so many institutions use iceberg orders and send orders to dark pools is to try to avoid the front running of HFTs. There are obvious drawbacks to doing that, such as having to execute most of your trades at the the back of the queue, so to speak, because icebergs have to constantly refresh after the orders in front and their visible order size are executed, putting them in the back of the queue most of the time. I have seen countless number of times when a large sell order enters the offer in the order book, the bid price gets hit instantly and turns offer. That is an HFT front running right there. Without spoofers to confuse the HFT algos, these algos get bolder and run amok, causing exacerbated moves as they are entering as the same side as the large order flow, taking liquidity, not providing it.
Buying or selling in front of large order flow is front running. HFTs will take out the offer, hit the dark pools, and sit there with an iceberg buy order in front of a large buy order they know is legit.
That's just profitable trading in my opinion. It's only when you obtain unfair access to information about order flow that it becomes problematic.
Great article. Anyone who is involves in markets full-time knows this is correct. HFTs invest $$$ in building front-running / momentum driving algo's that profit from front-running legitimate orders - they lose money when the legitimate orders turn out to be bluff orders. ...So the regulators BAN bluff orders? If you can't see the conflict of interest here then I can't help you. Anyone who trades size, full time, knows that offering/bidding size is not "risk free" - you get HIT on those orders. It can't be stressed enough - spoofing only works when their is front running! period! If NO ONE could see the order book, spoofing would be useless! Market intervention is not needed to create an equilibrium in the market. It will happen on it's own, arguably even more so with algorithmic trading now. For example: Week 1: an individual trader spoofs 10,000 lots in the ES repeatedly and causes frequent 4-5 tick reaction lower. Upon being hit on their bids lower, they pull the offer and bid the market higher for repeated profits. Week 2: traders are used to seeing the 10,000 lot trader and input bids 4 ticks lower ready to get filled, anticipating he will cancel the fake offer, and the market will reverse higher. down tick reaction is now 2-3 ticks instead of 4-5 ticks. Week 3: a larger trading operation has noticed the frequent spoofer and grown tired of it - they program an algorithm that said: If=>10,000 appears on offer, lift it, bid the price for size and squeeze the trader out. Week 4: After getting hit repeatedly, the spoofer on the ask stops the strategy due to losses incurred. That is NATURAL MARKET FORCES. Those of you who have been around since the Paul Rotter days - his spoofing strategy was profitable because no large participants had ever seen the need to have large clip sizes in their risk limits. They would see the large order on the bid/offer and be willing to take it, but their clip size was too small. This (of course) eventually changed, large institutions saw they could get their entire order off at one price, increased their clip sizes, and his strategy stopped. It didn't require government intervention. But today instead, regulators sided with the group of traders who pay the exchanges the largest amount of money and employ lobby groups. Imagine if the regulators sided with the traders "bluffing" and made a rule that it was illegal to hit in 1 clip orders > 500 lots. Imagine how much more money those strategies would now make. That's basically what the regulators have done for HFT front-running strategies - attempting to guarantee that every order you front-run is legitimate. Hilarious... PB
Spoofing is part of the game. It's not illegal over here, it's actually very common and we learn how to deal with it. UBS HFTs are playing all the time even with Spoofing, so obviously there are ways to counter it and still execute HF trades.
It really is simple. Allow both front-running and allow spoofing. Then the market is fair. If you tilt the playing field to one method, then the market is rigged. Also, if you are going to jail spoofers, you need to start jailing the creators of HFT programs. It is only fair.