Trick or treat in the Markets
By Richard Matthews, 29 August 2017
With the seemingly early Autumnal weather in London my mind has drifted towards the fast approaching celebration of All Saints Day and the now widespread practice of Trick or Treat played on that evening. But what has this children’s game got to do with the markets? Well In February 1637, the price of the recently discovered Tulip Bulbs reached extraordinary heights and then collapsed with some bulbs reportedly reaching the price of a house. The events surrounding this event are described in Charles Mackay’s “Madness of Crowds” and are universally accepted as a textbook case of false asset price inflation, trick or treat on an industrial scale . Speculative bubbles have ballooned and burst many times over the centuries, and there has nearly always been an element of Spoofing. In plainer English speculators offering to buy or sell markets without any intention of actually doing so. To some part and parcel of any market but increasingly frowned upon by the authorities.
Most seasoned traders first experience of learning how to spoof was believe it or not from a game played and enjoyed in pubs and bars wherever traders gather. It’s certainly still played and as a colleague pointed out, when I asked him about spoof “how would you ever decide who pays for the taxi without it?” Simply explained a number of traders, in this instance let’s say three, get together and put three coins in their hands. The hands are then placed behind the back and a number of coins out of the three are moved around, after a period of time each participant holds a fist out containing between zero and three coins. If there were 3 people playing the maximum coins in the three hands would obviously be nine and the minimum zero, then everyone calls out a number that they believe is the total number being held in the playing fists. The skill is in calling out a number which doesn’t expose the number you are holding and keeping a straight face. The winner is the person who guessed the correct number and he would then drop out of the game. The loser is the last man standing and their forfeit? Well it is to pay for the next round in the bar, a taxi fare or maybe even a meal accompanied by a wish that they had taken trick or treat more seriously as a kid.
On the old trading floor locals, banks and brokers would show huge orders above the market or just below to try and influence its direction. For example, a local may have shouted five for a thousand when there was only a small offer at six hoping that gullible players would pay six and the market would head in his direction. Did he really want them? The only way to find out was to try and lift the offer and then watch his reaction – either a look of panic would creep over his face or smug satisfaction that he had suckered you in. All fair in my book and I would venture the books of most professional traders. You played or died on your ability to read people and markets and react quickly enough not to get hammered. Believe me people did spoof and get caught, be it in the futures, commodity or FX markets and paid the price.
A simpler more straight forward time I hear you argue and the advent of electronic trading, algorithms and chat rooms have indeed changed the market forever. The CFTC in America has for a long time taken a dim view of the practice of spoofing and see it akin to market manipulation which at times it is .Under section 747 of Dodd-Frank the CFTC and the largest futures exchange, the CME, were given the ability to crack down. The act amended the Commodity Exchange Act making it unlawful for a person to engage in any trading, practice or conduct subject to the rules of a registered entity such as a futures exchange that “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).
The innocent trader’s game of holding undisclosed numbers of coins in your hand has changed significantly with the rapid incursion of technology into the markets. It is no longer always a human brain behind the spoofing indeed more often than not it’s an algorithm designed to publish orders and kill them in the same instant. Alongside this there are increasing cases of traders colluding through chat rooms to actively rig the markets through spoofing. As these cases have increased so have the punishments and they are indeed, at times, draconian. Continual spoofing of markets by specially written computer programmes and coordinated spoofing through collusion are without a doubt damaging and seem to be being taken seriously by the authorities but does the punishment fit the crime? In previous incarnations as far back as one can go in the markets the punishment for getting caught spoofing was that you ended up wearing the position and taking the financial implications of that decision. But times have changed. Whilst Michael Coscia, the first person convicted under the anti-spoofing provision of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, petitions the US federal appeals court that recently upheld his conviction (Three years imprisonment) for a re-hearing, it’s hard not to realise that the game has changed and its deadly serious for those who now play.
Richard Matthews, who began in career in 1973, is a former trader-broker in the London money, futures and foreign exchange markets. Twitter @dickiematthews5
This column is the opinion of the author and does not necessarily reflect the opinion of LiveSquawk.