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In finance, quote stuffing refers to a form of market manipulation^[1] employed by a variety of algorithmic traders that involves quickly entering and withdrawing a large number of orders in an attempt to flood the market.^[2] This can create confusion in the market and trading opportunities for high-speed algorithmic traders.^[3] The term is relatively new to the financial market lexicon and was coined by Nanex in studies on order entry behavior during the 2010 Flash Crash.^[4]

By quote stuffing, trading systems delay price quotes while the stuffing is occurring, simply by placing and canceling orders at a rate that substantially overwhelms the latency of market data feed lines. The orders pile up in buffers, and the delay (increased latency) lasts until the buffer drains. Trading systems slow down a direct exchange feed whenever they want, and the phantom orders do not need to be in a particular stock; they can be in any of the securities that cohabit the particular price (market data) feed. For example, phantom orders at the rate of over about 10,000 messages/second, even for fractions of a second, delay the NYSE's CQS feeds.^[5] Exchanges profit by selling higher-capacity feeds to HFT traders, which disincents self-regulation that could prevent the quote stuffing.^[6] Quote stuffing happens frequently – when 6,400,000 replacement orders for one stock are crammed into a second, each order is valid for less time than it takes for the news of the order (traveling at close to the speed of light) to reach anyone not at the exchange; no normal person can execute a trade against the phantom order.^[7]

Debate

While quote stuffing is commonly described as a deliberate tactic to gain an unfair advantage over slower participants by flooding the market with large quantities of non-bona fide orders, some in the HFT industry argued that the phenomenon could be a software error.

HFT-associated voices

Zachary David, who works at a trading firm that uses “automated, algorithmic, quantitative” strategies,^[8] writes that when a person or an algorithm rapidly places and cancels an order, it is often called “flickering”, and that flickering is largely caused by feedback loops. Without safeguards in place, unwanted behavior can occur.^[9]

Chris Stucchio, who worked for Mesh Capital where he “devised and implemented strategies for high-frequency trading”,^[10] wrote in April 2014 on the topic. He argued on his blog that the practice known as quote stuffing may be an accidental “software bug” and a “buy high, sell low” trading strategy.^[11] Stucchio suggested that a HFT trader who engages in quote stuffing “puts his own capital at risk” and increases “liquidity” for buy side investors.

Independent voices

Investor and Dallas Mavericks owner Mark Cuban addressed quote stuffing on his blog as a deliberate practice intended to deceive other participants. “There is a problem in the markets known as quote stuffing. This is where HFT create quotes that are supposed to trick other algorithms, traders, investors into believing there is a true order available to be hit. In reality those are not real orders. They are decoys. (...) And not only that, it creates such a huge volume of information flow that it makes it more expensive for everyone else to process that information, which in turn slows them down and puts them further at a disadvantage.”^[12]

Academic research

Diaz and Theodoulidis presented analysis contrary to the claim that HFT firms use the tactic to provide liquidity. It was rather shown that the potentially abusive and manipulative behavior known as quote stuffing is able to increase the gap of best bid and ask prices, thereby increasing costs for ordinary investors. The researchers concluded that “it is possible for a [high-frequency] trader to profit by artificially, highly frequently creating bandwidth in trading data feeds that would make arbitrage possible by taking advantage of the HFT induced price differences between markets.”^[13]

Regulatory action

In 2010, the Securities and Exchange Commission (SEC) began looking at the practice to assess whether it violated existing rules against fraudulent or other improper behavior. At the time, SEC Chairman Mary Schapiro said the agency was considering requiring traders to hold orders open for minimum periods.^[14]

On June 16, 2014, Nasdaq posted a disciplinary action against the high-frequency trading firm Citadel Securities LLC due to several rule violations that included quote stuffing. Citadel was found to have “failed to prevent the strategy from sending millions of orders to the exchanges with few or no executions.”^[15] It was further pointed out that Citadel “sent multiple, periodic bursts of order messages, at 10,000 orders per second, to the exchanges. This excessive messaging activity, which involved hundreds of thousands of orders for more than 19 million shares, occurred two to three times per day.”^[15]

While Citadel did not admit or deny wrongdoing, it accepted the fine of $800,000 imposed by U.S. regulators for trading violations. The HFT firm was ordered to pay $420,000 of the fine to Nasdaq, $160,000 to NYSE, $170,000 to BATS, and $50,000 to FINRA. According to John McCrank of Reuters, the sanctions came as regulators clamp down on issues related to high-frequency trading that had received greater scrutiny since the release of the Michael Lewis book Flash Boys.^[16]

See also

• Algorithmic trading
• Feedback loop
• High-frequency trading
• Market manipulation
• Software bug
• Flash crash

References

External links

• http://lexicon.ft.com/Term?term=quote-stuffing “Quote Stuffing”