Ghosts in the order book

The stock markets have come a long way from the days of the open outcry system.

- SANDEEP PAREKH

Offers and bids for stocks, once shouted or hand-signalled on trading floors, now reside in electronic and anonymous order books.

These books reveal more than just orders; they provide crucial information on bid-offer balance, market depth, and the prices traders are willing to accept. Order books offer a glimpse into the push and pull of the market—a vital piece of the mosaic of information that shapes market prices.

However, this leaves the order book open to manipulation or "spoofing," a practice that usually involves placing non-bona fide orders of large quantity on one side of the market, while attempting to execute a bona fide order on the other.

For instance, a trader places buy orders for huge quantities of X, but at a price lower than the market price. The probability of his orders getting filled is fairly low, because common sense dictates that no seller would sell lower than the market.

The bid, however, which may make up a sizeable portion of the order book, may signal higher demand for X, leading to other traders selling X at higher prices. The manipulative element kicks in when the trader also places a sell order at these prices, which are higher than they would have been if not for his own earlier buy orders.

These fictitious orders, usually fully visible to the market, are designed to create an artificial impression of demand or supply. These buy orders are then conveniently cancelled after the trader books a profit and, true to their name, are nothing more than a "spoof" that the trader has no intention of seeing through.