The job of a market maker is to ensure that there is always a counterparty for buyers and sellers; an MM takes a chaotic marketplace and, for those who need it, presents the illusion that (for instance) you can buy a security the same way you buy a book on Amazon: here's a price, click buy, done.

If you try to think about it, it's hard to get your head around how MMs can provide this service. Ensure a counterparty to buy from, or sell to? The market is constantly moving. From where do they get the superpower of always having stuff to sell, or always being able to buy? How are they not taking a bath doing this?

One reason MMs can exist is because they charge a premium and pay a discounted rate for the securities they charge. The premium you pay an MM when you buy a security offsets the risk that they're getting the fuzzy end of the lollipop, which, if it happened over and over again, would force the MM out of business.

But: it's tricky to charge a premium (or pay a discount) against an estimated fair market value that is constantly changing. Also: the size of the premium/discount (the spread) depends on factors that also constantly change.

For me, knowing these things makes it intuitively obvious why MMs need to constantly submit and cancel new orders. It's like the edits in a simple diff algorithm; cancellations are the "-" lines, order entries are "+" lines, and a "change" in an order requires both.

"the fuzzy end of the lollipop"? I can guess the context, but I have absolutely no idea what that analogy means.

EDIT: http://www.urbandictionary.com/define.php?term=fuzzy+end+of+...

HFTs place and cancel orders with the goal of getting fills. They rapidly place and cancel orders with the goal of getting fills at the best price. They also engage in all sorts of other practices (e.g., buying order flow) designed to get more fills.

I.e., if the nbbo for SYMB is $10.00/10.10, an HFT might place an order at $10.01, then a bunch more pile on. Then the market moves down and the HFT cancels the $10.01 order and puts in another one at $9.95, in the hope that SYMB will move down to meet him. The goal is to get a fill from an uninformed (i.e. small) trader.

In contrast, this guy was deliberately avoiding fills, and more importantly, sent an email proving this was his goal. (That latter part is very important when the illegality of a specific action varies depending on what your goal is.)

My understanding is that this guy did exactly the same thing you've described a HFT would do. The intention of $10.01 is to move a price, not to get a fill.

No, the intention of 10.01 is to capture the fill when the market goes there. The intention of a spoofer is to induce the market to go somewhere it shouldn't, jump the hell out of the way so as not to fill at that bad price, and then profit from the correction back to the right price.

It is legal to change your mind quickly. It is illegal to place an order with the intention to cancel it before it executes.

But what does "intention to cancel" mean when you're offering to sell stock at an above-market price? What if I'm perfectly happy letting someone buy that stock from me because I can replace it at a lower price once the market settles? I'm still trying to manipulate the market prices, but am I "spoofing"?

If you're actually willing to trade at that above-market price if the market moves suddenly, then that's a legitimate strategy and not manipulation. You're playing the role of a shock-absorber. If your plan is to cancel as quickly as possible if you see the market moving toward you, then that's illegal.

But I can do both of those at the same time. Let's say I'm willing to trade at that price if the market moves suddenly, but I want to change my offer if the market moves slowly. Am I intending to cancel now?

he's referring to the unconditional intention to cancel an order. if any of the future states of the world result in you wanting to trade the order that you placed, it is a valid order.

Great, then the smart spoofer isn't spoofing! Because they accept that they might actually trade the order.

Even if they admit to spoofing as a general activity, they're just talking about the common case. They're not placing orders with unconditional intention to cancel.

Well that doesn't lead to a very helpful law...

You could say the same thing about almost any law. The difference between an accidental fire and arson is criminal intent. While in theory it's not possible to observe someone's inner mental state, in practice their outward actions usually give a pretty good clue, and edge cases where the same actions could be interpreted either way are rare. The same is true in spoofing: while it's theoretically possible that exactly the same strategy might be used by a legitimate trader and by a spoofer, differing only by intent, in practice some strategies are overwhelmingly more likely to be spoofing. The edge cases are tricky, but they don't invalidate the entire concept.

In this particular case, the trader in question would have been financially ruined if his spoofed orders had been executed, so it's pretty clear he didn't intend for them to be.

Caveat: In my opinion, this isn't a distinction well suited to the criminal justice system. I'd rather that exchanges identify probable spoofers and ban them from trading (after some warnings), with the burden of proof (in arbitration) on the accused to show that the suspicious orders were part of a legitimate strategy.

>In this particular case, the trader in question would have been financially ruined if his spoofed orders had been executed, so it's pretty clear he didn't intend for them to be.

Are you sure? If he bought the stocks at the heightened price he could just resell them right away. I'd have expected it would take a much more permanent shift to ruin him.

Or if I put it another way: It seems to me that there is a solid method for making money that's 95% the same as spoofing and 5% actually being happy when your "fake" orders execute. So the intent is still to manipulate the market but only through truthful orders. Then you can no longer look at this pattern of behavior and say that it's overwhelmingly likely to be spoofing. Now what do you do? Do any laws stop this?

Which makes the law entirely unenforceable unless the perpetrator is dumb / arrogant / ignorant enough to brag about it...

But these are high-frequency trades, which mean that they're executed by a computer programmed to do that. If you can examine exactly what it was programmed to do then that could probably help prove intent.

"You're honor, it wasn't me, it just deep-learned it that way."

If a program uses AI to come up with strategies, how do you make sure it doesn't learn to spoof? Coming up with the goal-formulation of "don't spoof" seems like it would require the program to introspect about its own intent. Dunno, I would like to hear what kind of metrics one would use to make the learning algorithm reject spoofing strategies. I guess it would be something similar to whatever heuristics the SEC uses to flag potential spoofing, but they get a lot of false positives and almost never convict someone on metrics.

>> Not sure why this guy is being prosecuted.

It's traditional to praise the big finance houses when they pull this stuff, but for individuals it's a crime, because they found a way to 'cheat' the big boys.

Here's another example - http://www.computerworlduk.com/news/security/3244186/norwegi...

Could you find the most specific example you can of a large investment bank (or equivalent firm) being praised for manipulating the market? Specific enough that we can actually dig into what specifically they're being praised for doing?

Any central bank since 2008.

Wow, that case in contrast to the current one actually seems absurd. Upon further research though they were cleared of any wrongdoing on appeal in 2012 [1]

[1] http://www.ft.com/intl/cms/s/0/e2f6d1cc-9447-11e1-bb47-00144...

You are right that most place and cancel orders rapidly, but that isn't necessarily spoofing, which requires some intentionality. For example, Nasdaq even has an order type that auto-adjusts itself such that it will never execute, but it was mainly created to help market-makers dodge quoting requirements, not to enable spoofing.

In symbols where they are a registered market-maker, market-makers are supposed to be obligated to make a market in the symbol. In exchange they get several regulatory benefits, like being able to naked short a stock (sell it without even locating/borrowing the shares).

In practice most automated market-makers used to just put out bogus quotes they never expected to fill at $0.1/$1000000.0 bid/ask. The SEC tried to regulate this and say you had to really be making a market and put your quotes within X% of the current bid/ask. Market-makers started automatically cancelling and replacing at exactly X% away, but that was too much for them. So they had Nasdaq create an order type that automatically cancels itself and replaces it X% away from the bid/ask anytime the NBBO changes.

What they are doing in that example is completely wrong, but not analogous to what the guy in this article was allegedly doing (this guy put his quotes near the money to make fake interest, market-makers put theirs as far away from the money as possible to be fake market-makers and get regulatory benefits like naked shorting in exchange, their orders don't appear like real buy/sell interest in the same way this guy's allegedly did).

---

The author of the article tries to distance algorithmic-HFT from this guy operated, to cleanse its name, but come one:

    Sarao may have been a spoofer, but he doesn't seem to
    have been doing the sort of high-speed algorithmic
    trading that usually qualifies as "HFT." He himself 
    claimed to be "'an old school point and click prop 
    trader' who had 'always been good with reflexes and
    doing things quick,'" and the "Layering Algorithm"
    that he used was a customized version of "a program
    that allowed non-programmers to engage in automated
    trading using spreadsheet commands and functions." He
    was also the sole owner and employee of his trading
    firm, which he "operated from his residence." In style
    and substance he is not all that different from other
    spoofers we have known and loved, who did their high
    speed trading by just punching keys really fast.

In style and point-and-click background maybe he wasn't a goliath HFT operation, but in substance, spreadsheet automated trading at faster than human speeds, he definitely was.

--

If the charges hold up, they will have been able to convict this guy because of evidence of intentionality (the emails to his FCM). But with trading strategies now starting to delve into modern deep-learning techniques, we're probably going to start seeing algorithms learn to spoof from a blank slate. The only way to tell if one of these algorithms is really intending to buy or sell or is spoofing would be to reverse engineer something rather inscrutable... And is it the author's intentionality or the algorithm's we're really concerned with? Likely we'll end up holding things to some gamable metrics that will do about as good a job as the market-maker quoting requirements do in assuring market-maker algorithms are providing liquidity.

It seems like the real fix would be to have a cancellation fee. If an order is canceled within 60 seconds, penalize the trader .1% of the total amount of the order. That would make all this gamesmanship unprofitable, and the order book would actually be a collection of people wanting to buy and sell shares.

It seems very wrong to me to make an activity feasible, and allow it to be profitable, but then arbitrarily drop the hammer of criminal penalties when a trader crosses some murky line.

There already is. If you add liquidity you get a bit of a bonus, if you remove it (cancel your limit order), you are charged a small amount.

Why are people so fixated on the order book? The real information is the spot price and how fresh is that information (and the volume), the order book is a fantasy anyhow. There are people willing to buy stuff at pennies always, and sell at thousands. How does that help you? What if they cancel? It shouldn't matter if someone does it closer to the spot price, or closer to the best bid-offer.

If you want to buy, look at the price, decide how much you think it's worth, put in a limit order at that price. Go to bed. If you want to sell, basically do the same. If you want to live on trading, then smarten up.

> Nasdaq even has an order type that auto-adjusts itself such that it will never execute

That's not true, the order could execute if someone slams the market with a massive buy / sell order. It auto adjusts to stay away from the active market. The idea behind the order type is that you don't want to be at the current 'market price' but rather just outside to handle big fish. You might argue this sucks, but the the big fish don't mind as it gives them more liquidity that wouldn't otherwise exist. The trade also lightens load as you don't have to constantly send cancels.

You're being really pedantic, yes a single big sell order that blew through the entire book in one go could hit it. After the regulation was added, but before Nasdaq added the auto-adjusting type, market-makers, in stocks they didn't really feel like market making in just constantly cancel-replaced their order each time the quotes changed, a single whale order could have hit those too.

Maybe you aren't being pedantic: are arguing the intent of the regulation was to have market-makers make markets only as a bulwark against single whale-orders that will probably be thrown out as clearly erroneous?

That is a real role-redefinition. A quoting obligation that falls apart if the big-order trader on the other side randomly decided to break his order two (or N) near-simultaneous orders?

I'm not being pedantic at all. It's the whole point of the order type and Market Making. Being a provider of liquidity as last resort. This order type is only available for MMs, btw.

Ideally, the order will never execute as the regular market will handle the volume. Things are in bad shape when you have to dig into the Market Maker's pockets.

order type description: https://www.nasdaqtrader.com/content/productsservices/tradin...

Ok, you are saying market makers are there to handle single whale orders, and not floods of one-sided orders during rumor panics etc. And you are saying that market makers should be obligated to take on a single whale order, but if the same whale-order-placer instead splits his whale it into chunks and simultaneously places them, maybe to hit multiple exchanges at once, the market maker obligation goes away as long as the first chunk is small enough not to blow away the book.

Yep, the order type is only for market-makers. That's pedantic too; I only ever talked about it in the context of market-makers, as an example of place-cancel not being the same as spoofing. I'm not sure if you are pointing this out to say I am conflating them. Maybe I should have picked a more noble non-spoofing example?

Just a reminder that this is an instance where we are saying someone is engaging in "algorithmic HFT" from a house 4000 miles away from the trading venue, using what appears to be Excel and Visual Basic.

How is flashing $2.5 billion in orders at super-human speed not "algorithmic HFT"?

You maybe have equated HFT and ultra-low-latency trading in your mind? The latter is almost always high-frequency because it is hard, on a few pennies per trade, to make any money without the F in HFT, frequency. But all areas of HFT aren't necessarily so latency sensitive as areas like index-underlyings arbitrage where you have to be colocated at the exchange to be competitive and 4,000 miles away sounds like a ridiculous punchline.

At a heavily automated market-maker I worked at, we, not so long ago, had all our servers almost a thousand miles from new york, even farther from Chicago, and still did about 8 or 9% of all US equities volume. It sure as fuck didn't run on Visual Basic, but you would be surprised how much algorithmic trading does out there.

If you want to call one guy's Excel plugin-in talking to Globex from London HFT, that's fine; I'm just saying: that's what were talking about here. If HFT includes things you could run on a WinXP-era laptop with WinXP-era software --- again, fine --- then we're in a weird place w/r/t/ the idea that HFT is something further segmenting the market into haves/insiders and have-nots/outsiders.

The "2.5 billion in orders" is just a number; in fact, the unreality of that number is the problem.

This seems really naive. A lot of HFT is taking something a trader has figured out and can do in real time for one symbol, automating it, and applying it to 2000 symbols at once. A WinXP era-laptop can be fine, if the trader's strategy worked at human-scale latency and limited human input bandwidth on one symbol, a WinXP-era laptop might indeed be able to do the same for some thousands of symbols.

I think we might be a bit biased on this site because a lot of the HFT recruiting targeted at techies in other industries is going to be in cutting-edge areas of ultra-low-latency or generically-dealing-with-massive-data where experience in a different industry can directly cross over.

I think you think I'm making an argument I'm not making.

For the most part, I think HFT is innocuous.

For the most part, HN does not think HFT is innocuous.

All I'm suggesting here is, if an Excel plug-in talking to Globex from London is "HFT", that shoots a hole in one of the primary arguments used against HFT here.

Really, what we're running up against here is the silliness of the term "HFT". By the definition we're contemplating here, virtually every ATS in the world is an HFT.

> that shoots a hole in one of the primary arguments used against HFT here.

Which one specifically? That the big players have an unfair advantage over the little guy?

> Really, what we're running up against here is the silliness of the term "HFT". By the definition we're contemplating here, virtually every ATS in the world is an HFT.

Not really, if it doesn't deal with market micro-structure, it probably isn't HFT. There are lots of ATSes that do routine things like rebalancing portfolios, or more sophisticated things like automated hedging of human traders, that is still happening at a human pace.

I haven't seen a detailed article yet that covers how many order modifications he made, and how far outside the money his spoof orders were (really far and it is something he could have managed by hand and I wouldn't call it HFT, pennies-close and his London Excel setup couldn't have handled it, but I think there is definitely a big HFT Goldilocks zone in there).

Look, spoofing is already illegal, and is already a problem in manual trading. Whether the guy did HFT spoofing or not isn't really damning to HFT at all. It really just shifts attention away from how fast all the illusionary HFT liquidity (tightening spreads and providing valuable liquidity is how pro-HFT arguments normally counter anti-HFT arguments about it a zero-sum game) evaporated during the flash crash.

My original comment can shed some light on that. Part of the regulators' approach, post flash-crash, to getting more liquidity in events like that was to add more stringent quoting obligations on market makers. The regulation was already ineffective and poorly thought out, but to get an idea of how much the industry really values liquidity don't look at the bullshit they sell in congressional hearings (we pay the market in liquidity!), but instead look at the product they demand as customers of Nasdaq (a new, explicitly anti-liquidity order type).

(edit: ok a bit overblown on that last part, I don't think the flash-crash was that big of a deal. The HFT industry just really oversells liquidity and it is kind of a farce, the market literally shuts down for two days each week and takes ten days of holiday each year.. literally a near universal zero liquidity for 30% of the year or more if you consider market hours)

Wouldn't that be illegal under Dodd-Frank then?

Do you know the name of that type of order?

He's probably referring to a Market Maker Pegged Order.

Thanks! Love HN.

> Not sure why this guy is being prosecuted.

You have to start somewhere / make an example of someone. Lone wolves trading from their houses have fewest friends and are easiest targets. Hopefully they go after bigger fish as well.

Compete fantasy. Eric Holder is on record stating he did not pursue criminal charges against large financials because of systemic risk.

One law for some, another for everyone else.