NEW YORK (Real Money) -- Tuesday's big story, away from the hustle and bustle of earnings season, was the arrest of Navinder Singh Sarao by British authorities (in cooperation with the U.S. Department of Justice).
Sarao is being accused by the U.S. Commodity Futures Trading Commission (CFTC) of "unlawfully manipulating, attempting to manipulate and spoofing" the E-Mini S&P 500 futures (Es) contract. The CFTC's complaint goes on to allege that Sarao was "engaged in a variety of other manual spoofing techniques whereby defendant(s) would place and quickly cancel large orders with no intention of the orders resulting in transactions."
Despite claims that Sarao has engaged in illegal trading practices, such as spoofing, on numerous occasions since the 2010 flash crash, the DOJ's focus appears to be squarely on the defendant's key role in the (day-timeframe) events that triggered the May 6, 2010 flash crash.
Anyone actively involved in the markets from a day-timeframe trading perspective has likely witnessed orders, often very large orders, flash on the bid or offer (or just slightly outside the national best bid or offer) only to be canceled within a split second.
This incessant entering and canceling of orders is known as spoofing. In a nutshell, the participant entering the orders has no intention of allowing said orders to be executed. He is simply trying to create the illusion of extreme supply or demand. As the fake supply pushes prices lower, the participant can bid into the weakness, completely cancel all his fake orders, and sell his recently acquired inventory into the price rebound. It may be a bit more complicated than that, but not much.
Let's be very clear about this: Short-term futures traders aren't the only ones affected by spoofing. But since day-timeframe equity scalping has faded in a huge way since the 2008 financial collapse, the majority of participants have both adjusted and evolved, while accepting that regulatory agencies are incapable of curbing the practice.
Aside from traders accepting spoofing and other practices commonly (and often incorrectly) associated with high-frequency trading as an unavoidable cost of doing business, many in the news media continue to think such practices have little effect on mom and pop investors.