Spoofing The Market

Yesterday it was reported in the Wall Street Journal that JP Morgan Chase was going to pay $920 million to settle a market manipulation investigation DOJ, CFTC and SEC tied to manipulation of precious-metals and Treasury markets.

These market manipulations were tied to a practice called spoofing.

Spoofers typically send large orders to futures exchanges intended to change the appearance of supply and demand. If prices move in response, the spoofers may succeed at their goal—getting a smaller order filled. They then cancel the larger order as quickly as possible. The law was changed in 2010 and forbids the practice of sending misleading orders that traders don’t intend to have executed. The problem with spoof orders is that it leaves the counterparties with a loss on the cancelled orders.

The practice which is illegal is alleged to have occurred hundreds of thousands of times.

The Commodity Futures Trading Commission provides oversight over the commodities market for precious metals. Not only did JP Morgan pay a fine, they also admitted to misconduct. Three traders, two of whom still work for Chase and a third who left the bank in 2009 were charged criminally in the case. The charges were filed in Chicago Federal court about a week ago.

In addition to spoofing and other federal offenses, the indictment charged all three men with racketeering, a claim that is more typically found in cases against organized crime entities. Authorities said it represents the first time that defendants accused of spoofing electronic derivatives markets have been charged with racketeering.

While the government has been active in outlawing the practice in commodities trading, the practice is believed to be widespread and largely unmonitored in the market for federal treasury bills.

Spoofing is closely linked to a form of market manipulation that we experience all the time. It’s rooted in a psychological concept called anchoring. Anchoring sets an arbitrary expectation by drawing an imaginary line in the sand.

If you go to one of the department stores that’s not bankrupt and buy an Armani suit, you might find it on sale for, say $1,300, marked down from $2,000. It’s a bargain at $1,300 and so you decide to buy it. But wait a minute. Who said it was $2,000? Was the $2,000 real or was it a fabrication designed to manipulate the consumer?

Would the buyer truly pay $1,300 for that same suit if they thought the retail price was $1,200, or $1,300 or $1,400?

How often do we see manipulation in real estate markets? Have you ever seem multiple offers for the same property? One or two offers are substantially below the asking price and then one offer comes in at a more reasonable, but still low number? The seller, starts to get conditioned to the idea that their asking price is too high and feels compelled to take notice of the lower offers as being representative of what the market will bear. Acting out of fear, they accept the reasonable offer. The same buyer of course was behind all of the offers and they simply wanted their third offer to be accepted.

The one thing that causes these manipulations to be effective is another human emotion, called FOMO, or fear of missing out. FOMO, combined with anchoring is at the root of most market and negotiation manipulations.

Property managers often schedule multiple tenant appointments at a vacant apartment for the same time. If some of these prospective tenants are not real tenants, they can create the false perception of high market demand for the apartment. The property manager might say, there are many people interested in this apartment. You should apply in the next hour if you have any hope of getting the apartment.

You can start to spot these manipulations with a bit of training.