What is Quote Stuffing?
Quote stuffing is the practice of entering, and then immediately canceling, a massive number of orders to buy or sell stocks. It is a tactic employed by high-frequency traders (HFT) in an attempt to profit by manipulating the market price of a stock or stock index.
Basically, a trader is “stuffing” the order pipeline with huge numbers of orders that are likely to impact the bid and ask spread for a stock and deceive other traders, and that may cause slowdowns and other problems in trading exchange systems.
Such a type of market manipulation is illegal in the United States and in most other major countries. In an attempt to prevent quote stuffing, many stock exchanges have created new rules that prohibit traders from entering more than a specified number of orders per second. Other rules designed to combat quote stuffing specify a minimum time frame that must elapse before a trader can cancel an order.
Quote stuffing is a relatively recent phenomenon, as it was not possible prior to the development of the hardware, software, and algorithms that enabled high-frequency trading (HFT). High-frequency trading uses algorithms, high-speed financial data feeds, and powerful hardware and software to enable traders to enter and execute massive amounts of orders in just fractions of a second. The phrase “quote stuffing” is alleged to have been coined by Eric Hunsader, a software developer who has been a very outspoken critic of HFT.
- Quote stuffing is the practice of entering, and then immediately canceling, a massive number of orders to buy or sell stocks.
- Quote stuffing is an illegal market manipulation tactic.
- The practice was only made possible by technological advances that enabled large institutional investors to engage in what is known as high-frequency trading.
Here’s a simple example of how quote stuffing can work:
Assume that a trader has 500 shares of stock in ABC Company that he wants to sell at a favorable price – a price that is slightly above the current market price. In order to move the stock price higher, the trader quickly places 100 different orders to buy 1,000 shares of the stock – that would be a total of 100,000 shares. However, the trader placing these orders has no intention of buying any of the stock; he or she merely wants to manipulate the market price so that they can unload the 500 shares they already own at a good price.
The amount of demand represented by the mass of buy orders pressures the stock price higher. In addition, other traders seeing the volume of shares that one or more parties are apparently looking to buy may believe that something significant is driving the stock price higher – that leads them to also look to buy shares of ABC stock, which puts even more upward pressure on the price.
The original trader cancels all of their buy orders and places an order to sell their 500 shares at the increased market price. They have turned a profit while possibly luring many other investors into making investments that may cost them money, as the supposed demand that they saw for the stock was mere “phantom” or not real demand.
Quote Stuffing and Arbitrage
Another way in which high-frequency traders may aim to profit from quote stuffing is through arbitrage trading. Arbitrage trading attempts to profit from small, temporary differences that exist between bid and ask prices quoted for the same security on different trading exchanges.
As a simple example, assume that the bid and ask prices quoted for Stock A on one exchange are $101 and $102, respectively. Further, assume that the bid and ask prices quoted for Stock A on a different exchange are $103 and $104, respectively. By placing simultaneous market orders to buy the stock on the first exchange and sell it on the second exchange, a trader can buy for a price of $102 and sell for a price of $103, thus locking in a $1 profit.
To help create the disparity in price between exchanges, the trader can engage in quote stuffing, flooding the exchanges with buy and sell orders and cancellations of those same orders. High-frequency trading is capable of entering thousands of orders within a matter of milliseconds.
Stuffing massive amounts of orders and order cancellations into the system can confuse and slow down price quotes – this is known as creating latency in data feeds – which is more likely to result in slight discrepancies between the bid and ask quotes from one exchange to another.
Quote Stuffing – The Domain of Large Investors
The only traders that can engage in quote stuffing are market makers and large institutional traders that have a direct access link to the various stock exchanges and that are equipped with the necessary hardware and software to engage in high-frequency trading. Unfortunately, this group of traders now account for more than half of the total dollar volume of all stock trading.
While high-frequency trading is not, itself, an illegal practice, it does provide the means for traders to engage in illegal practices, such as quote stuffing. It also places the large institutional traders who can practice high-frequency trading in a position of having an advantage over regular traders.
Therefore, the potential problems posed by high-frequency trading – which was considered a causal factor in the stock market’s 2010 Flash Crash, when the Dow Jones Industrial Average (DJIA) dropped almost 1,000 points and then recovered nearly all of the loss in just a little more than half an hour – continue to be strongly debated within stock market regulatory agencies.
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