Author: Joseph Young

Carefully! Lots of text.

Spoofing is a method of market manipulation by placing fake buy or sell orders that are always canceled before execution. Spoofing typically uses algorithms and bots to manipulate the market and asset prices to create a false impression of supply or demand.

Spoofing is prohibited in many major markets, including the US and UK.

Introduction

The market is believed to be controlled by large traders and whales. Although such claims are often easily debunked, there are several common methods of market manipulation using large assets, one of which is spoofing.

What is spoofing

Spoofing is a way of manipulating markets by placing orders to buy or sell assets (such as stocks, commodities and cryptocurrencies) that will not actually be executed. Typically, traders use bots or algorithms to automatically place buy or sell orders to manipulate the market. When the order gets close to execution, the bots cancel it.

The purpose of spoofing is to create a false impression of market sentiment. For example, a spoofer may open several fake buy orders to simulate demand at a certain price level, and when the market approaches this level, the orders are closed and the price continues to fall.

How markets react to spoofing

Often the market reacts extremely negatively to fake orders, since it is not yet possible to accurately determine whether an order is real or fake. Spoofing is especially effective if orders are placed based on key areas of interest for buyers and sellers, such as  support or resistance.

Let's take Bitcoin as an example. Let's say it has a high resistance level at $10,500. According to technical analysis, the term "resistance" refers to the area where the price reaches a "ceiling". It is expected that it is at this level that sellers will place bids to sell their assets. If the price deviates at the resistance level, it may fall sharply, while if the resistance is broken, there is a high probability of further upward movement.

If the $10,500 level appears to be quite strong resistance, then bots will likely place fake orders just above it. When buyers see large sell orders above this level, they may lose interest in actively buying at this level. In this way, spoofing can be used to manipulate the market.

Note that spoofing will also be effective in markets pegged to the same underlying instrument, as large counterfeit orders in the derivatives market can affect the spot market for that asset and vice versa.

When spoofing is ineffective

Spoofing can be risky when there is a high likelihood of unexpected market movements.

Let's assume that a trader wants to refuse to sell at a resistance level. In the event of a strong rally, fear of missing out (FOMO) among retail traders can cause huge volatility and fake orders will be filled quickly. This will be disadvantageous for the spoofer since he had no intention of entering the position, and due to a short squeeze or sharp crash, even a large order can be filled in a matter of seconds.

When the market trend is primarily driven by the spot market, spoofing becomes increasingly risky. For example, if the spot market is trending upward, indicating high interest in purchasing the underlying asset outright, spoofing will be less effective. However, this often depends on the specific market environment and many other factors.

Is spoofing illegal?

Spoofing is illegal in the US. The US Commodity Futures Trading Commission (CFTC) oversees spoofing in the stock and commodity markets.

In the US, spoofing is illegal under Section 747 of the Dodd-Frank Act of 2010. Under this section, the CFTC regulates organizations that:

demonstrate willful or reckless disregard for the orderly execution of operations during the closure period; engage in “spoofing” (creating demand or supply with the intention of canceling before execution).

It is not yet possible to definitively determine whether canceled bets in the futures market are spoofing, unless it is of a recurring nature. This is why regulators take into account the purpose of placing orders if suspicious behavior is observed in a user.

Other major financial markets, such as the UK, also regulate spoofing. The UK's Financial Conduct Authority (FCA) can fine traders and organizations responsible for spoofing.

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Why spoofing is bad for markets

So, spoofing is illegal and has a detrimental effect on markets, but why? Spoofing causes price changes that are inconsistent with actual supply and demand, while the spoofers themselves profit from price movements.

US regulators have long expressed concerns about market manipulation. As of December 2020, the US Securities and Exchange Commission (SEC) has rejected all Bitcoin exchange traded fund (ETF) proposals. If approved, the ETF will give traditional US investors access to an asset such as Bitcoin. There are usually several reasons for rejecting offers - one of them is that the Bitcoin market is considered susceptible to manipulation.

However, this will not always be the case as the Bitcoin market enters a new phase with increased liquidity and participation from institutional investors.

Summary

Spoofing is a method of market manipulation that involves creating fake orders. There are methods for detecting spoofing, although this is often difficult to do. To understand whether deleting buy or sell orders is spoofing, it is necessary to conduct a thorough analysis of the intent and purpose of creating the orders.

In any market, every effort must be made to minimize spoofing and maintain a balanced environment for all participants. With regulators citing market manipulation as a reason for rejecting Bitcoin ETFs, efforts to minimize spoofing could benefit the cryptocurrency market in the long run.

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