Success at Trading: market depth

Manipulation : spoofing simulation

https://www.bloomberg.com/graphics/2015-spoofing/

Manipulation : Spoofing example

On the morning of May 6, 2010, the Dow Jones collapsed almost 1,000 points in a matter of minutes before bouncing back. Navinder Singh Sarao went to jail for the part he played in it. He used to be hailed as a legend by his peers after he made $50 million trading from his bedroom, till he caused the May 6 fiasco. The illustration below shows how the flash crash panned out.

Spoofing is also called dynamic layering. It’s a form of market manipulation where you pretend you want to sell a lot of stock, and everyone's all, "Oh in that case I want to sell a lot of stock too," and the stock goes down, and then you actually buy a some stock, and you wait for a second or two and then pretend you now want to buy a lot of stock, and everyone's all, "Oh well now I want to buy a lot of stock too," and the stock goes up, and you actually sell back the stock you bought.

Here’s a simple illustration of how it works:

You select a stock that has enough liquidity but not too much.
Britannia’s future contracts seems appropriate for this. The futures contracts are trading at Rs 3000.00 on the NSE. You’ve got a co-location server with a broker who’ll allow your spoofy trades, which means that your trading speed is now in microseconds (1/1000000th of a second).
You place a IOC (immediate or cancel) sell order for 187 lots at Rs 3020.00 (Layer 1), comfortably above the market price so your orders don’t get filled. This order does not fill immediately because you’re selling way above the current market price.
The daily trading volume in the contract is around a thousand lots, so your trade gets noticed by 20 other HFT/algo trading firms. Their algorithm’s think, “Hmm, looks like some large institution is selling their stock, prices will fall, I better go short too.”
Their selling pushes the price down to Rs 2970.00. You now cancel your Layer 1 sell order and replace it with 20 lots of buy orders at Rs 2972.00 (Layer 2). Now these buy orders are legitimate. You now own 20 lots of Britannia stocks at Rs 2972. This buy order fills immediately because you’re buying at a price > the current market price.
Now you have to be extra careful, and fast because now you have exposure to 20 lots and hence have downside risk.
You now place buy orders of 150 lots each at Rs 2980, 2990 and 3010 and you immediately cancel them. You got to make sure the orders are canceled immediately so that they don’t fill. Most spoofers use algorithms to do this but then there are people like Aleksander Milrud who hired armies of Chinese and Korean humans traders and equipped them with special gaming keyboards with hot keys to place orders unbelievably fast [1]
Buy orders that have been cancelled remains on the order book of the NSE (can be viewed on any NEAT, ODIN terminal) but is not longer floating in the market to be filled.
The entire process is now reversed. The same 20 HFT firms now think, “Oooo, looks like someones buying a lot of Britannia futures, maybe its Mr. Jhunjhunwala, I better get in before price rises too much.”
In a few minutes, prices rises to Rs 3010 and you exit your 20 futures lots.

Manipulation : Spoofing & Layering

“Spoofing” and “layering” are both forms of market manipulation whereby a trader uses visible non-bona fide orders to deceive other traders as to the true levels of supply or demand in the market.

Some regulators use the terms “spoofing” and “layering” interchangeably, while others, including FINRA, use “layering” to describe entering multiple non-bona fide orders at multiple price tiers, and “spoofing” to describe entering one or more non-bona fide orders at the top of the order book only.

In spoofing patterns, a trader enters a single visible order, or a series of visible orders, that either creates a new best bid or offer or adds significantly to the liquidity displayed at the existing best bid or offer. During the lifespan of that first order(s), or within a short time after it is cancelled, the same trader executes a trade on the opposite side of the market. The pattern is manipulative because the execution occurs at a more favorable price than the trader was likely to obtain in the absence of the first order(s). This is true regardless of whether the buy (sell) execution occurs at the pre-sequence best bid (offer) price, at the midpoint, or at the new best offer (bid) price set by the spoof order. In any of those scenarios, the trader is executed at price better than if he had hit the pre-spoof bid or had taken the pre-spoof offer.

Layering is a variant of spoofing where the trader enters multiple visible orders on one side of the market at multiple price tiers, which cause the midpoint of the spread to move away from those multiple orders, and the same trader executes a trade on the opposite side of the market. Again, the pattern is manipulative because the execution occurs at a more favorable price than the trader was likely to obtain in the absence of the first orders.

If the trader enters orders at multiple price tiers that successively set the new best bid or offer as they are entered and remain live after the newer orders are entered, as in the figure above, the same pattern could be described either as spoofing or layering.

For more on the differences of layering versus spoofing, you can learn more about spoofing here, and learn more about layering here.