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Investment stock market Entrepreneur Business team discussing and analysis graph stock market trading, stock chart conceptTrading in commodities or securities has come a long way from the days of Dan Ackroyd and Eddie Murphy shouting out orders for orange juice futures on the trading floor in the 1983 film “Trading Places.” Few exchanges now have pit trading at all and over 90% of securities trades happen through electronic trading platforms. The beginning of electronic exchanges led to the emergence of high-frequency trading, or HFT. HFT is a subset of algorithmic trading, the use of algorithms—preprogrammed electronic instructions—to undertake nearly all parts of the trading process, with computers replacing human beings. HFT traders use these computer algorithms to place and respond to thousands of orders per minute at virtually the speed of light—milliseconds (one thousandth of a second) or even microseconds (one millionth of a second). HFT firms represent roughly 2% of trading firms but are said to account for 73% of all equity bids and orders volume. At its simplest, HFT technologies allow traders to devise arbitrage strategies which compare prices for a given security trading on different exchanges at different pricing, buying the lower and selling the higher and turning a small profit, typically less than a penny per share, but doing so thousands and thousands of times a day.

“Although high-frequency trading has legal applications, it also has increased market susceptibility to certain forms of criminal conduct.” United States v. Coscia, 866 F.3d 782, 786 (7th Cir. 2017). Notably, the practices of certain HFT traders has brought legislative and enforcement attention to the ill-defined practice known as “spoofing.” In a typical spoofing scenario, a trader who wants to buy a certain commodity or stock places an order for the amount he or she wishes to buy, at a price slightly below the current market price, while simultaneously placing much larger orders to sell (referred to as “spoof,” “phantom,” or “trick” orders)—signaling to other traders a surplus of supply and creating the illusion of downward market movement. This causes the price to drop until it reaches the level of the (smaller) buy order and it is filled. The trader then cancels the (much larger) sell orders. Once the trader acquires the commodity or stock at the price he or she wanted, he or she can then sell it at a higher price by doing the same thing in reverse, pushing the market price up. Spoofing is designed to trick other traders into buying or selling by sending a misleading signal about supply and demand. While no one questions the need for regulators to root out deceptive conduct that manipulates markets, aggressive enforcement tactics are causing great uncertainty for participants in the markets concerning their own lawful conduct.

The Commodities Exchange Act makes it unlawful for a person to engage in “trading, practice, or conduct [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 statute carries a maximum penalty of 10 years in prison and a $1 million fine. 7 U.S.C. §6c(a)(5). The statute applies to both HFT traders and “manual” traders, but it applies only to commodities as Dodd-Frank did not amend the securities statutes to outlaw spoofing by name in the securities market. Notwithstanding this attempt to define what is prohibited by the statute, it is widely acknowledged that that the term “spoofing” lacks a common meaning in the futures and derivatives industry, and although the CFTC has attempted to clarify Congress’s language, the difference between legitimate market activity and illegal spoofing remains, in the view of many, somewhat muddled.

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