Wednesday, 24 July 2013

"Layering", Spoofing, Spiving & "false" market orders

The FCA recently fined a trader for "layering" ; fca pdf link

Details are incredibly important when discussing the mechanisms of trading.

A brief synopsis of Mr Coscia's strategy; to buy a contract, he'd place a small bid at the best bid, and simultaneous a larger sell order above the best offer, then he'd place further sell orders in the order book above the best offer, when he got filled on the bid he'd pull his sell orders.

In essence the charge is that he is manipulating the order book and giving a false impression of the "real" demand and supply.

As Mr Coscia’s large orders were so unlikely to be executed (due to their short 
resting time on the order book and inevitable cancellation once the small order 
was executed or they were partially executed) they created false impressions of 
liquidity rather than genuine market supply and demand.

The market participants who were most likely to trade with Mr Coscia and be 
impacted by his trading strategy were HFT market participants or traders using 
algorithmic and/ or automated systems rather than manual traders.

At least one significant market participant withdrew from ICE during the Relevant 
Period directly as a result of Mr Coscia’s trading pattern which reduced liquidity 
for other market participants as well as resulting in the loss of trading 

 I have a serious problem with this sort of charge. An order is an order, you have no obligation to leave it in the market for a certain length of time. The reason that other market participants like resting orders is because they provide the opportunity for profit for other traders.

For example a large and stationary bid is a great opportunity for "pennying", resting or leaning on. say a trader put in an order to pay 51.50 for 3000, and the order book is 3000 x 51.50 / 51.60 x 100. This allows other traders to bid 51.51, when they get filled they have almost a guaranteed stop loss of 0.01 and can offer out the stock they've picked up at 51.60, ie to make 9c profit only risking 1c.

The other way to see the cost of this latency, is to imagine that you had to leave your order for a long period of time, you'd suffer from a serious amount of adverse selection.

Anyone placing an order whether they "want" it to be filled or not, is taking risk. It makes no difference whether you trade with a "spoof" order or a "real" order the transaction is the same.

Market participants that are trading on the information in the order book are not liquidity providing. If when you see a large sell order you are "spoofed" into selling on the bid, then you are taking liquidity out of the market, I don't think Warren Buffett is there smashing the bid in KO every time he sees a thousand lot offered up two ticks above the best offer. If anything spoof orders can only help long term investors and retail traders as they provide cover for their resting orders and provide additional bid and offers that they may agress against.

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