Quote Stuffing

Quote stuffing is the rapid entry and withdrawal of large block orders upon the market of a security. The purpose of quote stuffing is to deceive competing traders and investors by overwhelming a given market with bid/ask price quotes. Forex, contract-for-difference, equities and futures products are common targets for the practice.

Advances in trade-related technology has made the implementation of quote stuffing possible. Trade in the contemporary digital marketplace is conducted at near-light speeds. Cutting-edge devices such as direct market access (DMA) and black-box systems give traders the ability to place or withdraw large orders in the blink of an eye.

Given ultra-low latency access, as well as adequate capital resources, an individual or firm may place sizable orders upon a select market in as little as 400 microseconds.1)Retrieved 8 October 2018 https://www.routerfreak.com/low-latency-networks-financial-trading-applications/#A_microsecond_can_make_the_difference The combination of speed and automated order execution have made quote stuffing the backbone of many trading strategies.

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Practitioners

The practice of quote stuffing may be attributed solely to the discipline of high frequency trading (HFT). HFT is defined by the U.S. Securities and Exchange Commission (SEC) as the use of ultra-low latency market access and sophisticated software programs for generating, routing and executing orders.2)Retrieved 10 October 2018 https://www.sec.gov/marketstructure/research/hft_lit_review_march_2014.pdf

There are three primary groups of market participants that employ HFT systems on the financial markets:

  • Institutions: Commercial banks, central banks and large brokerages are examples of institutional market participants. They act as market makers and liquidity providers, profiting from facilitating the process of price discovery.
  • Proprietary Trading Firms: Also known as “prop firms,” these entities profit from applying private systems and strategies to the marketplace via advanced technological infrastructure.
  • Large Retail Traders: Although not as common, well-capitalised retail traders have the ability to engage in HFT practices. Through the use of DMA, co-located servers and algorithmic trading systems, sophisticated retail traders may engage in strategies involving order stuffing.

HFT firms have been documented placing and retracting large block orders in adherence to various quote stuffing strategies. This practice boosts relative levels of order flow, and in turn, traded volumes.

As of 2017, HFT accounted for almost 60% of traded volumes on the U.S. equities markets and more than 60% of select futures contracts listed on the Chicago Mercantile Exchange.3)Retrieved 9 October 2018 https://www.ft.com/content/d81f96ea-d43c-11e7-a303-9060cb1e5f44 Participation levels on over-the-counter (OTC) markets such as the forex are difficult to determine due to the lack of transparency and standardised format.

One method of employing quote stuffing within the context of a passive HFT strategy is to influence the bid/ask spread of a security. By sending and recalling high volumes of orders to and from a market, the bid/ask spread fluctuates in anticipation of pending liquidity. By capitalising upon variations in the spread, these firms can act as a de facto market maker, providing liquidity in exchange for a fixed profit.4)Retrieved 11 October 2018 https://www.inet.econ.cam.ac.uk/working-paper-pdfs/wp1801.pdf

Regulation

Officially, quote stuffing is considered to be artificial market manipulation and an illegitimate trading strategy on par with spoofing. It is deemed detrimental to market efficiency, undermining the process of price discovery by artificially inflating buy or sell-side pressure.5)Retrieved 11 October 2018 http://www.finra.org/newsroom/2010/finra-sanctions-trillium-brokerage-services-llc-director-trading-chief-compliance While officially illegal, finding ample evidence and proving malicious intent has been a challenge for regulatory bodies.

In order to limit the frequency of malicious trading practices, many exchanges and markets self-regulate in accordance with official guidelines. In May 2013, the Commodity Futures Trading Commission (CFTC) put forth Rule 575 that defines and explicitly prohibits the act of quote stuffing:6)Retrieved 11 October 2018 https://www.cmegroup.com/tools-information/lookups/advisories/market-regulation/files/RA1405-5.pdf

  • “Submitting or cancelling bids or offers to overload the quotation system of a registered entity, and submitting or cancelling bids or offers to delay another person’s execution of trades.”

Penalties have been levied against perpetrators by the Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission. The most notable of which stemmed from the 2010 flash crash, where the Dow Jones Industrial Average plummeted 700 points in minutes, partially because of quote stuffing practices.7)Retrieved 11 October 2018 https://www.reuters.com/article/us-sec-trades/quote-stuffing-a-focus-in-flash-crash-probe-idUSTRE6812ZS20100902

Summary

While illegal and unethical, quote stuffing remains a factor in the equities, futures and forex markets. Prosecuting firms and traders in violation of formal guidelines is often difficult due to the lack of market transparency, especially as related to OTC venues. However, regulatory bodies such as the CFTC, FINRA, and the Financial Conduct Authority, continue to work at preserving the integrity of markets around the globe.

Any opinions, news, research, analyses, prices, other information, or links to third-party sites contained on this website are provided as general market commentary and do not constitute investment advice. The market commentary has not been prepared in accordance with legal requirements designed to promote the independence of investment research, and it is therefore not subject to any prohibition on dealing ahead of dissemination. FXCM will not accept liability for any loss or damage including, without limitation, to any loss of profit which may arise directly or indirectly from use of or reliance on such information.

References   [ + ]

1. Retrieved 8 October 2018 https://www.routerfreak.com/low-latency-networks-financial-trading-applications/#A_microsecond_can_make_the_difference
2. Retrieved 10 October 2018 https://www.sec.gov/marketstructure/research/hft_lit_review_march_2014.pdf
3. Retrieved 9 October 2018 https://www.ft.com/content/d81f96ea-d43c-11e7-a303-9060cb1e5f44
4. Retrieved 11 October 2018 https://www.inet.econ.cam.ac.uk/working-paper-pdfs/wp1801.pdf
5. Retrieved 11 October 2018 http://www.finra.org/newsroom/2010/finra-sanctions-trillium-brokerage-services-llc-director-trading-chief-compliance
6. Retrieved 11 October 2018 https://www.cmegroup.com/tools-information/lookups/advisories/market-regulation/files/RA1405-5.pdf
7. Retrieved 11 October 2018 https://www.reuters.com/article/us-sec-trades/quote-stuffing-a-focus-in-flash-crash-probe-idUSTRE6812ZS20100902