To begin, I don't understand why the argument that spoofers have the risk of getting their orders hit (bluffs called) by aggressive traders necessarily makes their practice anymore legitimate. A pump and dump scheme comme Wolf of Wall Street has risk; a short seller could call their bluff and blow it up in their face. Does that make pump and dump schemes acceptable? Just because they have risk doesn't make a practice legitimate. Mexican cartels have risk. I think we can all agree that price changes are a function of order flow, so if you agree with the above notion that front running is the act of knowingly entering the market before large order flow, then you should agree that all traders are attempting to front run - HFTs, human beings day trading, and buy and hold investors alike. Taking this logic further, if spoofing indeed misleads those attempting to front run, spoofing then affects all market participants negatively. If your argument was that "we want to curtail HFT, so we suggest allowing spoofing orders to persist for 1 millisecond" or some time horizon that only would be actionable by HFTs, then you might have a plausible argument for why allowing spoofing would lead to less of the front running that folks on this thread and Arnold seem upset about (i.e. HFTs picking off funds rebalancing, iceberg orders, etc.). However in practice, we aren't talking about orders that last 1 ms; we're talking about spoofing orders that stay in the book long enough to mislead a significant number of traders. It takes a sucker for spoofing to work. HFTs are smarter than you're giving them credit for. They adapt to market conditions. If there was an equilibrium of spoofers and institutions trying to disguise flow, HFTs would move away from this approach. If there were more spoofers, they would get in on the opposite side of the spoof like the trader attempting it and try to ride the suckers who implicitly believe that markets move toward size. You aren't going to stop sophisticated traders attempting to take advantage of flow by allowing spoofing; you're just going to introduce more noise to the book and, by extension, the market in my opinion. Remember, everyone is trying to get in front of order flow, whether you're looking at my timeframes or John Arnold's. I think there's room for an honest discussion about allowing spoofing in some form, but I don't think that allowing a long banned deceptive practice just because it will temporarily marginally disrupt HFTs makes sense. Here's a good blog on the topic.
With all due respect, the allegation that it is somehow immoral or unfair to posture a certain intention while secretly devising the opposite, with the goal of gaining an advantage in a business transaction, cannot be defended in a free society, IMHO. In fact this happens continuously in all manner of transactions, dealings, etc in the USA. By the same token it is illegal and generally accepted as immoral to steal, which is essentially what front running does, in the guise of forced inter-mediation. Again, don't take this the wrong way, but, this is somehow eerily reminiscent of the Bush administration's approach to stalling policy advancement on global warming. Got any ties to the HFT industry?
What my post and others who have posted arguing in favor of 'spoofing' is that a one sided argument is being put forward. "Bluffing" has been around since the the beginning of markets trading in the pits. You can even see in the infamous Paul Tudor Jones documentary him sending in fill or kill "show the size" orders into the Oil pit via phone brokers. Where has this sudden discussion of "legitimate" orders and "illegitimate" come from? A common description is the evil manipulative trader sends in fake orders, tricking the hard-working legitimate "other" traders into also buying, who then find out that perhaps it was a bad idea to buy just because you incorrectly thought other participants had submitted large orders to buy. That is ludicrous! There is no legitimate and illegitimate traders - we are all just traders attempting to deploy strategies that produce $$ - this has nothing to do with investors. Investors aren't ever going to be making a decision to buy/sell a stock based on the depth. This is only about the participants sitting around the market "poker table" to use MarketOwl's analogy. Let's go back to a real world example. A HFT trader programs a market making algo that bids at best bid and offers at best ask in a thin market overnight to earn a nice return. They roll out the algo across 10 markets and enjoy a nice $$ return. One day, prior to a US holiday, the market is exceptionally thin, and there are virtually no bids and offers in one of the markets. A trader who watches this market closely notices the poorly programmed algo running it, and bids a 1 at 10000. The algo joins his prices. The trader deletes his 1 and sells into the algo. The trader then offers at 9990 and the algo joins his offer. The trader closes out his trade for a profit. He repeats this process until the person running the algo decides perhaps this strategy isn't so smart after all. The HFT algo creator, feeling cheated, complains to exchange - "Hey, I lost money on my stupid strategy, I assumed no one would ever bid above the high and then offer below the low, that person didn't have an intent to trade, and if they hadn't been allowed to bid and offer at those prices, I wouldn't have lost money!" The exchange notices the strange action in this particular instrument and fines the trader for manipulative practices, and cancels the trades during that time period. It is laughable. The exchange rewards the poorly designed strategy and fines the person who took advantage of it. The HFT has no incentive to be careful of what they are designing, and traders have to be careful not to exploit an inefficiency by taking advantage of poorly designed strategies. To be clear, the ideal situation is none of the above occurs. We don't want wild, erratic, illogical market moves. But the only way to stop it, is for their to be a disincentive to programming stupid strategies in the first place. In the above scenario had the exchange not gotten involved, the HFT learns it's lesson, programs something smarter next time, and everyone goes about their business.
I don't take any of the above as disrespectful, so no worries. With regard to the first quote, I'm not trying to pass judgement on the morality of any of these practices. My intention is not to liken spoofing to being in a drug cartel, it's to show that a strategy assuming risk doesn't necessarily mean that no market manipulation is taking place. Secondly, I think I we could both easily come up with some scenarios where the aforementioned strategy of deception is unlawful. Prices changing is the result of either a risk adverse market maker (anyone using a limit order in this context) changing their BBO or order flow coming and taking all that is offered at a given price. It follows that if you are a profitable trader, you front run order flow. That doesn't necessarily imply that you've obtained the information asymmetry in an immortal fashion; that would be tantamount to stealing. On the count of ties to the industry: if you count an internship, yes. That being said, I think my previous post explains why I believe spoofing affects all market participants. Bad information about order flow leads to uninformed attempts at front running. Since all market participants are attempting to front run order flow, spoofing therefore impacts all traders. Also, there's a lot more to HFT than simply trying to predict where icebergs are. Most HFTs are simply market makers no different than a specialist in the 90's for the purposes of our discussion here.
You're ignoring virtually all mean reverting strategies. Many strategies are providing liquidity to absorb order flow at prices they determine as irrational, and earning their return from then exiting the position when the prices return to rational levels, either in an outright or via spread positions.
I apologize but must place you in the Biased detention center now. There is just no getting around this. That said, I read your post carefully and objectively. It has not altered my opposing opinion and may have reinforced it a bit. Thx for your input tho
That's fine. I respect your right to ignore me. That being said, please appreciate that I wouldn't go into the HFT industry if it was just a parasitic mob of nerds who left jobs in academia and big tech to rip of funds rebalancing.
I'm not ignoring you, I respect your position and disagree with it. If I insisted on being my typical dick self I would say that I respect your decision to ignore reality while in the pursuit of a justification for an immoral act from which you will be the beneficiary, or something to that effect... But I am not going to be my usual self.
So if I'm employing a mean reverting strategy where I offer liquidity, yes I am indeed hoping to have enough uninformed flow come in to take out the guys in front of me and then hit my bid or offer, but how do I make money? I'm anticipating that this flow will reverse and I'll get filled on an opposing order or exit by going market after price has reverse, which of course also requires informed order flow to drive prices in the opposing direction. Both of these outcomes require me anticipating order flow and getting in (by being filled on a limit order in this point, which in itself requires anticipating flow to place the furthest away order that will be hit) before a reversal in direction of order flow. In this way, we are again front running order flow, we are just relying on a passive order being hit to avoid paying the spread. It is still front running order flow in the definition posited earlier.
It is clear that this is an argument between two parties: One party (large traders, institutions, and spoofers) that wants no special parties (like lobbying HFTs) to be favored over others. The other party (front running HFTs) who want to handicap others (spoofers) who hurt their profitability by making up subjective standards for legal and illegal order cancelling of large orders. Unfortunately, in the court of public opinion (as seen by the jury outcome in the spoofing trial), spoofing is bad. The retail public immediately hears spoofing and think that its bad for the markets because it causes them to make rookie mistakes when looking at the order book. And they want to be protected from their own stupidity and greed in the markets.