Next Monday, September 15th, may be a very interesting day if the CME actually follows through on the new rules it has recently announced. It has, shockingly, finally decided to make bogus (read: illegal) HFT manipulative orders and market rigging against the CME rules.
As you will read at the end, the new rules take effect in a few short days. Before that, however, I am reprinting a very well received missive of mine on this exact subject.
I want to state that I am not against algorithmic trading or HFT in general; however, there are several extremely borderline-illegal “techniques” that I am indeed against. If you are faster than I am and make a profit earlier than I do, or more of it because of the speed, that’s OK. But what I am against is using this speed, which incidentally is about as close to the speed of light as you can get over cable/fiber lines, for illicit gains.
As we have recently found out, I am not crazy; these “special techniques” are not special at all, but illegal as we have said all along. A specific type of trading that we have discussed is “spoofing,” which employs fake orders – those that are never intended to be filled – in order to entice others to trade based on this false information.
In this type of “trade” an aggressive HFT manipulator will (for example) place enormous buys under the current price, after they have sold short. The enormous bids under the current market are fake of course, which is how this scam works. The purpose of this scam is to entice other people, and other algorithms, to buy because they can see the huge bids under the current price. The thought buy people and the code of algorithms are to buy NOW before the lower bids creep higher or “go to the market” and it races higher without them. They don’t want to be left behind. Specifically, they trade because of those big orders below the market, but unbeknownst to them – they are all spurious.
What happens when these huge orders, which many have specifically traded on, have disappeared? When they are cancelled, the exact reason for the other people and algorithms that caused their purchases, are gone! They will then exit their longs by selling, which creates an instant profit for the original illegal HFT program.
Canceling the intentional fake orders creates a vacuum and the market quickly drops. Once there were thousands of buy orders under the market and a microsecond later they have vanished, which makes it easy for the market to drop.
Two firms were (surprisingly) recently busted for this exact illegal activity. It only took the regulators about SIX YEARS to catch on.
And it has taken the CME even longer to make new rules, but new rules have indeed been made. Hold on to your hats – the CME “claims” that it is taking away the ability of HFT to be manipulators, which it calls “Disruptive market practices.”
Examples of Prohibited Activity – The following is a non-exhaustive list of various examples of conduct that may be found to violate Rule 575:
Single asset class manipulation: The market participant places orders to induce or trick other market participants. (This is SPOOFING!)
Cross Asset Manipulation: A market participant enters one or more orders in a particular market (Market A) to identify algorithmic activity in a related market (Market B). Knowing how the algorithm will react to order activity in Market A, the participant first enters an order or orders in Market B that he anticipates would be filled opposite the algorithm when ignited. The participant then enters an order or orders in Market A for the purpose of igniting the algorithm and creating momentum in Market B.
Price manipulation at the open: During the pre-opening period on CME Globex, a market participant enters a large order priced through the IOP (a bid higher than the existing best bid or an offer lower than the existing best offer) and continues to systematically enter successive orders priced further through the IOP until he causes a movement in the IOP, which prompts him to cancel all of his orders.
More tricking around closing and opening prices: A market participant places large quantity orders at the beginning of the pre-opening period in an effort to artificially increase or decrease the IOP with the intent to attract other market participants. Once others join the market participant’s bid or offer, the market participant cancels his orders shortly before the no-cancel period.
Arbitrage on demand: A market participant enters a large number of orders and/or cancellations/updates for the purpose of overloading the quotation systems of other market participants with excessive market data messages to create “information arbitrage.”
Quote Stuffing: A market participant enters order(s) or other messages for the purpose of creating latencies in the market or in information dissemination by the Exchanges for the purpose of disrupting the orderly functioning of the market. (This is just like a DNS attack on the internet that shuts down websites (denial of service)).
Using Self Match Prevention mechanisms to aid in price manipulation: A market participant enters a large aggressor buy (sell) order at the best offer (bid) price, trading opposite the resting sell (buy) orders in the book, which results in the remainder of the original aggressor order resting first in the queue at the new best bid (offer). As the market participant anticipated and intended, other participants join his best bid (offer) behind him in the queue. The market participant then enters a large aggressor sell (buy) order into his now resting buy (sell) order at the top of the book. The market participant’s use of CME Group’s Self-Match Prevention functionality or other wash blocking functionality cancels the market participant’s resting buy (sell) order, such that market participant’s aggressor sell (buy) order then trades opposite the orders that joined and were behind the market participant’s best bid (offer) in the book. (This is queue jumping!!)
Question: As of this writing and for many YEARS now, hasn’t the very same exchange actually not only tolerated but turned a blind eye to such disruptive market practices? Moreover, hasn’t the CME also compensated said “disruptive practices” by calling them “liquidity providers” and them rebating them? And with this rule, the CME is admitting that DNS attacks, spoofing, and QUEUE JUMPING are happening, or this wouldn’t be happening.
One more thing; read the list above and try to wrap your mind around what’s actually happening in the markets by these huge firms. They do not use “magical indicators” to make their money; the good firms use excessively complicated mathematics and statistics, while the bad actors simply cheat.
Will Rule 575 also apply to the central banks that the CME finally admitted were trading (buying only) the ES and other markets, like (selling only) Gold & Silver?
Oh well, until Monday – let the rigging continue!