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What is Spoofing In The Financial Markets?

BitForex Editor
Jan 11, 2021

A lot of people often make reference to how large whales and traders manipulate or exploit the market. While most of these theories or speculations can be disputed easily, there are, however, some well-known and notable means of market manipulation that requires large holdings. One of these methods is commonly known as spoofing.

Spoofing revolves around market manipulation in which a trader places sell orders or fake buy with the intention of not wanting them to get filled by the market. Spoofing is usually carried out using bots and algorithms so as to manipulate the market and asset prices by creating a false sense of demand or supply. Spoofing is illegal across numerous major markets, including the United Kingdom and the United States.

Spoofing Explained

As earlier stated, spoofing is a means of manipulating the markets by putting in place false orders to purchase or sell goods, for example, cryptocurrencies, commodities, and stocks. Basically, traders who attempt spoofing the market use algorithms or bots to place orders to purchase or sell. The bots cancel the orders the moment they get close to getting filled.

Spoofing's main idea revolves around attempting to create a false impression of pressure associated with buying or selling. For instance, a spoofer will most likely set a vast number of fake buy orders in order to create a false sense of demand at a certain price level. Typically, as the market inches close to the level, they remove the orders, and the price continues to the downside.

Spoofing became popular with the rise of "high-frequency trading" or HFT. High-frequency trading allows for the implementation of large trade orders within a short amount of time. With the benefits that HFT provides, spoofing gains an enormous scope that offers the advantage or opportunity of moving the prices of the security to a larger extent, which will, in turn, allow for earning higher profits.

How Markets React To Spoofing

The market tends to respond strongly to spoof orders due to the fact that there is no efficient way of telling if it is a fake or real order. Spoofing tends to be efficient, especially if the orders are put at key areas of interest for sellers and buyers, such as significant resistance or support areas.

Using Bitcoin as an example, let's say Bitcoin has a powerful resistance level of 10,500 dollars. Based on analysis, the resistance concept revolves around a space where price locates a ceiling. If at a resistance level, the price can fall if it get rejected. However, if it breaks out of the resistance, then there is an increased probability of continuation to the upside.

If the 10,500 dollars represents a strong resistance, then the bots will most likely place spoof orders a little bit above it. When buyers see huge sell orders above such a fundamental technical level, it may result in them becoming less encouraged to aggressively purchase into the level. Through this, that is how spoofing becomes useful in manipulating the market.

One factor to take into account here is that spoofing can be effective among various markets that are tied to a similar underlying instrument. To cite an example, huge spoof orders in the derivatives market tend to affect the spot market of similar assets and vice versa.

When is Spoofing Less Effective?

There is a tendency for spoofing to become riskier, especially when there is an increased likelihood of unforeseen movements in the market. For example, let's assume a trader is seeking to spoof sell a resistance. The spoof orders can fill easily if there is a strong rally taking place, and the fear of missing out, present among retail traders, suddenly brings about a massive volatility. Generally, this is not beneficial for the spoofer as they had no intention of entering the position. In the same way, a flash crash or a short squeeze can fill even a large order in few seconds,

When a market trend is driven by the spot market, spoofing tends to become increasingly risky. For instance, if an uptrend is moved by the spot market, showing increased interest for directly buying the underlying aspect, in this case, spoofing may most likely become less effective. However, this greatly depends on the particular market as well as numerous other factors.

Is Spoofing Illegal?

It is important to note that spoofing is not legal in the United States. The CFTC, or rather the U.S Commodity Futures Trading Commission, is charged with overseeing spoofing activities in the commodities and stock markets.

It can be challenging to categorize canceled bids in the future market as spoofing unless the action occurs constantly. To this effect, regulators mostly consider the purpose for the orders prior to charging, fining, or making enquires about possible spoofing behavior. There are also other major financial markets that regulate spoofing, for example, like the U.K. Another body also permitted to fine institutions and traders involved in spoofing is the Financial Conduct Authority (FCA).

Why Spoofing is Bad For The Markets

As earlier stated, spoofing is not only illegal, but it also has a negative effect on the market; however, the question is, why? Spoofing most likely brings about price changes that aren't necessarily reflected in demand and supply. Meanwhile, spoofers control these price movements, which is why they can easily profit from them.

Concerns have also been expressed by the regulators in the U.S as regards market manipulation in the past. In December 2020, SEC, also known as the U.S Securities and Exchange Commission, rejected every exchange-traded fund proposal. An ETF, when approved, provides the opportunity for more traditional investors present in the U.S to gain access to an asset like Bitcoin. There are usually numerous factors outlined for rejecting the proposals, one of which is that the Bitcoin market is not considered immune to market manipulation.

Spoofing is generally a market manipulation strategy that revolves around setting fake orders. Most times, it is challenging, if not impossible, to identify consistently. Reducing spoofing is a general desire in every market as it aids in maintaining a balanced environment for everyone involved. As regulators frequently believe that market manipulation is the reason for the rejection of Bitcoins exchange-traded funds, however efforts to reduce spoofing could be beneficial in the long run to the cryptocurrency market.

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