What is Spoofing in the Stock Market?

Big storms easily shake the small trees. Similarly, in the stock markets, all the losses are going to dawn on the small and retail investors. SEBI, being the watchdog of the Indian Capital and Commodities market, realises this fact. And that is why they have laid forward certain regulations with a view to containing the spoofing activity in the market. 

So what are they? How is it going to impact you? There are certain questions that might be arising in your mind. But before we set forth to address them, it is crucial to find the meaning of what spoofing is.

Spoofing – Meaning

In 2010, the New York stock markets witnessed something that was an alarm to all the investors around the world. On that day, about 1 trillion dollars were erased only to be gained back in about an hour. This caused the US Department of Justice to run a quick check and made them to investigate deeper on the matter. They finally came to a conclusion that the incident was triggered by spoofing activity which was carried on by Navinder Singh Saro, a trader from London. He placed an order to buy a huge number of stocks of E-Mini and S&P 500 Index futures, only to cancel them later!

Spoofing is a practice wherein a trader places orders to either buy or sell a particular security but then, later on, modifies or cancels the order to make a profit out of it. Now you might ask... what is the point and what’s the profit? Well, look at the example below. 

Mr X places an order to buy some 1000 shares of ABC enterprise. This will increase the demand for the particular stock in the product. Following this, the price of the particular stock will rise. He will simply cancel the order and sell the shares he already holds. That way, he will be able to create a false demand and get a higher price for his sale than expected. 

Such activity is also termed as Layering and involves the use of a disruptive algorithmic trading technique. This might either create a lot of optimism or pessimism in the market. This is a form of market manipulation which is illegal in most countries. 

SEBI’s new Anti-spoofing rule

It is absolutely normal for traders to make changes or alterations or cancel orders while trading, particularly small investors. But the problem arises when you are dealing with large quantities, which is sufficient enough to create unwanted noise in the market. And SEBI ultimately aims to get control over the latter. And it has laid down the various parameters and rules for penalising those involved in spoofing in its circular issued on March 26. 

Starting from April 5 2021, SEBI will start penalising all those involved in spoofing activities by suspending their trading account temporarily. So anyone who makes excess modifications or cancellations to the orders placed will have to watch out for their heads with effect from the 5th of this month.

They will be implemented both in the client and proprietary level accounts. However, three parameters are being set to evaluate and penalise any trader. Those are --

• High Order to Trade Ratio (OTR) in terms of value.
• When a trader has a high number of instances or modifications of the order made.
• And making a high percentage of order modifications but a deferred or lower execution.

Say a person makes a violation under all the three categories specified above, it will be treated as one instance. However, if there is a violation suspected which does not fulfil all the specified criteria but results in failure to fulfil the orders placed will also be brought under the watch of SEBI and action will be taken accordingly. 

A maximum of 2 hours and a minimum time period of 15 minutes has been fixed as the time period during which the account will be suspended. The last 20 rolling trading days will be taken into account, and the action will be taken accordingly. Further, spoofing will lead to suspension of trading for the initial 15 minutes. Any additions events may lead to a higher time period of suspension calculated by 

                         No of instances * 15 minutes on a rolling day up to 2 hours.

The table below clearly explains the same. 

Importance to small investors 

Small retail investors enter the markets with a view to fulfil their financial goals and aims. They may or may not hold sufficient market knowledge and are vulnerable to these false perceptions created by market manipulators. As a result, they will be forced to act, bringing home huge losses. Further,

• It will help the investors and traders understand the real direction of demand and supply prevailing in the market.
• It will help SEBI keep a watch over people who are trying to make a profit using the various manipulative routes, and thus, save the penny investors and retailers. 

Final words

Along with the long list of regulations, the SEBI is keen on drafting new ones and helping the investors. In those lines, the new rules on the spoofing activity deserve a great round of applause. It has received a thumbs up from various market giants and operators, including Nithin Kamath, the founder and CEO of Zerodha.

What are your thoughts on the new regulation? Do you think it will help in regulating the market? Let us know in the comments below.