The stock markets are a wild place, and everyone is trying to gain an advantage. One way some traders bend the rules to gain an advantage is by “spoofing.”
Spoofing is a form of stock market and exchange trickery that traders and investors should be aware of. This tactic is sometimes used to change asset prices—whether stocks, bonds, or cryptocurrencies. Here’s how spoofing works, its legal ramifications, and everything else you need to know about market manipulation and spoof trading.
What Is Spoofing?
Spoofing is when traders place market orders — either buying or selling securities — and then cancel them before the order is ever fulfilled. In a sense, it’s the practice of initiating fake orders, with no intention of ever seeing them executed.
Spoofing means that someone or something is spamming the markets with orders, in an attempt to move security prices.
What’s the Point of Spoofing?
Because market prices are determined by supply and demand—for instance, the more demand there is for Stock A, the higher Stock A’s price is likely to go, and vice versa—they can be manipulated to gain an advantage. That’s where spoofing comes in.
By using bots or an algorithm to make a high number of trades and then cancel them before they go through, it’s possible for spoofers to manipulate security prices. For a trader looking to buy or sell a certain security, those valuations may be moved enough to increase the profitability of a trade.
Spamming the markets with orders creates the illusion that demand for a security is either up or down, which is then reflected in the security’s price. Because it would require an awful lot of “spoofed” orders to move valuations, spoofers might rely on an algorithm to place and cancel orders for them, rather than handle it manually. For that reason, spoofing is typically associated with high-frequency trading (HFT).
Is Spoofing Illegal?
If it sounds like spoofing is essentially cheating the system, that’s because it is. In the United States, spoofing is illegal, and is a criminal offense. Spoofing was made illegal as a part of the Dodd-Frank Act, which was signed into law in 2010. Specifically, spoofing is described as a “disruptive practice” in Section 747 of the legislation, straight from the U.S. Commodity Futures Trading Commission (CFTC), which is the independent agency responsible for overseeing and policing spoofing on the markets:
Dodd-Frank section 747 amends section 4c(a) of the CEA to make it unlawful for any person to engage in any trading, practice, or conduct on or subject to the rules of a registered entity that—
(A) violates bids or offers;
(B) demonstrates intentional or reckless disregard for the orderly execution of transactions during the closing period; or
(C) is, is of the character of, or is commonly known to the trade as ‘spoofing’ (bidding or offering with the intent to cancel the bid or offer before execution).”
Additionally, there are laws and rules related to spoofing under rules from the Securities and Exchange Commission (SEC), and the Financial Industry Regulatory Authority (FINRA), too.
Example of Spoofing
A hypothetical spoofing scenario isn’t too difficult to conjure up. For instance, let’s say Mike, a trader, has 100,000 shares of Firm Y stock, and he wants to sell it. Mike uses an algorithm to place hundreds of “buy” orders for Firm Y shares—an algorithm that will also cancel those orders before they’re executed, so that no money is actually spent.
The influx of orders is read by the market as an increase in demand for Firm Y stock, and the price starts to increase. Mike then sells his 100,000 shares at an inflated price—an artificially inflated price, since Mike effectively manipulated the market to increase his profits.
Give your money a chance to grow.
Trade stocks, ETFs, and crypto – or start an IRA.
Consequences of Spoofing
Because spoofing is a relatively easy way to manipulate markets and potentially increase profits, it’s also a fairly common practice for some traders and firms, despite being against the law. That transgression can cost spoofers if and when they’re caught.
For example, JPMorgan Chase was fined nearly $1 billion by the SEC during the fall of 2020 after the company was caught conducting spoofing activity in the precious metals market. Not only that, but the company also found itself in the crosshairs of the U.S. Department of Justice and the CFTC—all for illegal activity that occurred in 2015 and 2016.
But it’s not just the big players that can be on the receiving end of a smack down by the authorities. During August of 2020, an individual day trader was caught manipulating the markets through spoofing activity—actions that netted the trader roughly $140,000 in profits . The trader was ultimately ordered by the CFTC to pay a fine of more than $200,000.
Despite the cases that make headlines, it’s generally hard to identify and catch spoofers. With so many orders being placed and executed at once (especially with algorithmic or computer aid) it’s difficult to identify fake market orders in real time.
How to Protect Against Spoofing
There are a number of parties that are constantly and consistently trying to gain an edge in the markets, be it through spoofing or other means. For investors, it’s worth keeping that in mind while sticking to an investing strategy that works for you, rather than investing with your emotions or getting caught up in the news cycle.
In a time when a single tweet can send stock prices soaring or into the gutter, it’s critical for investors to understand what’s driving market activity.
Spoofing is meant to gain advantage in the markets, but as such it’s illegal and penalties can be steep. Beyond the spoofers trying to manipulate the market, spoofing has the potential to affect all investors. If spoofers are manipulating prices for their own gain, that can cause traders and investors to react, not realizing what is going on behind the scenes. While this is more of an issue for active investors or day traders, it’s something to be aware of.
For investors who plan to stick to a more traditional investing strategy, SoFi Invest® can be an appealing choice. SoFi Invest offers an active investing solution that allows you to choose your investments, as well as an automated investing solution that invests your money for you based on your goals and risk.
Photo credit: iStock/visualspace
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal. Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.
Third Party Brand Mentions: No brands or products mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third party trademarks referenced herein are property of their respective owners.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
External Websites: The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.