[1e-9]

Example:

1) Spoofer places an offer to sell a small amount at a high price.

2) Spoofer places a bid to buy a huge amount at a lower price.

3) The huge order to buy makes other buyers think the price is about to increase significantly, so they immediately buy at the Spoofer's higher price even though they would otherwise prefer to wait for a lower one.

4) Spoofer immediately cancels their large order to buy before anyone takes it.

5) Spoofer waits awhile and then goes back to 1), but reverses the buy/sell orders so they can capture an illicit profit.

[blancheneige]

>3) The huge order to buy makes other buyers think the price is about to increase significantly, so they immediately buy at the Spoofer's higher price even though they would otherwise prefer to wait for a lower one.

Wait a minute, how did we go from "facilitating the efficient exchange of assets" to "making it easier for speculator to gamble based on what other speculators are doing"?

edit: If anything, spoofing should be allowed to make the price discovery more efficient. For traders wouldn't trade as much based on what other traders are doing hoping to squeeze a short profit. Rather, if they really want in, they will get in with a market or fill-or-kill order at their desired price, period. And it will instantaneously snatch the lowest ask and go deeper into the order book if they want to allow slippage and get a bigger size as well. This would restrain all kinds of quick buck momentum trading and whatnot which only serve to increase the noise around the price and are purely speculative in nature.

[1e-9]

A few points:

1) I wasn't narrowing the discussion to speculators. Spoofing hurts all valid market participants.

2) Speculation does not imply gambling, although that is a common misperception. Speculation is merely placing an order in the direction of an anticipated future price move. It oftentimes counters the current price trend. Informed speculators make trades because they understand something about the market that many others do not. Bringing this information to bear on prices is beneficial to the price discovery process. Informed speculation adds stability and accuracy to pricing. Uninformed speculators are gamblers. They are often harmful to markets and they tend to not last long due to losses.

3) Reacting to perceived near-term supply and demand is not gambling. Are you a gambler if you wait for a buyer willing to buy your house at the price you think is fair? What if someone lies to you saying that the supply of homes like yours is much higher than reality and this information causes you to accept a lower-than-fair price? Would you consider that beneficial to your selling process?

4) You seem to be arguing that the price you want should not be affected by the true prices that others want. Nobody knows enough to price every asset accurately. The markets pool information from many sources to provide this service. Allowing false information is counter to the process.

[blancheneige]

>Speculation is merely placing an order in the direction of an anticipated future price move.

For the purpose of making a profit. If gambling doesn't sound like the right term then sure, call it speculation. But a skilled trader is no different than a skilled poker player.

>Informed speculators make trades because they understand something about the market that many others do not.

They think they understand. Hence the gambling part, for it is entirely probabilistic in nature. Further, are you referring to the market as given by its technicals or its fundamentals? In the latter case, the state of the order book should have no immediate bearing on that perception, as the order book should be a causal reflection of the asset's fundamentals. In the former case, if that perception is partially derived from the order book itself, then we are back to probabilistic inference, hence gambling.

>What if someone lies to you saying that the supply of homes like yours is much higher than reality and this information causes you to accept a lower-than-fair price? Would you consider that beneficial to your selling process?

No, I would look at the price of houses available right now, just like a trader who means to buy now looks at what the best available ask is. The difference is in trading you can execute nearly immediately, neutering the effect of a spoofed ask removed causally as a result of buying intent.

>You seem to be arguing that the price you want should not be affected by the true prices that others want.

The "true" price that others want right now is the last quoted bid/ask that can be immediately sold/bought into. And that one can't be "spoofed" without the risk of someone actually market selling into it before it has a chance to be cancelled, hence making it reliable.

Again, if you rely on the buy side of the order book to make a decision, then you are using a technical indicator, which you'd hypothesize is derived from fundamentals, rather than using your supposed superior understanding of fundamentals (external to the market) to better price the market (internal adjustment).

[1e-9]

In my world, every statement you made is incorrect. I get the impression that there is little I can say to change these strongly-held views. Perhaps you will at least reconsider your assumption that uncertainty implies complete unpredictability.

[1e-9]

In retrospect, I think my comment was rather dismissive. Sorry about that. Please ignore and consider my more recent response.

[1e-9]

> The "true" price that others want right now is the last quoted bid/ask that can be immediately sold/bought into.

A market maker does not want to buy at the last quoted price, as he makes profit by buying at the bid and selling at the ask in return for providing liquidity and holding an asset until someone else wants it. Additionally, the last quoted bid/ask can be far from a desirable price even for non-marketmakers due to illiquidity, volatility, or new information such as recent economic announcements.

> And that one can't be "spoofed" without the risk of someone actually market selling into it before it has a chance to be cancelled, hence making it reliable.

A spoofer does take a risk that someone might go for his fake order before he can cancel it. That doesn't keep him from being profitable on average. He'll tend to place his fake order close enough to a fair price to make others think there is an imbalance, but far enough away that it's unlikely to execute before he can cancel. This isn't difficult, which is why people still attempt it. Fortunately, it's easy for exchanges to detect frequent spoofing and they are getting better at policing it.

> But a skilled trader is no different than a skilled poker player.

> They think they understand. Hence the gambling part, for it is entirely probabilistic in nature.

It is true that there are people trading in this manner. Most drop out quickly. A few get lucky early on, which results in them taking longer to blow out or get cut off by their firm's risk manager. Either way, their fate is as certain as that of the frequent roulette player. The traders who last are the ones providing value to the market while limiting their risk. Ways of providing value include market making, arbitrage, and speculation. Let's focus on speculation since that seems to be the one you find most objectionable.

Informed speculation involves creating a unique understanding of a piece of the market and making trades when the market violates your model. If the model is good, these trades nudge prices back towards rationality and tend to lead to profit. If the model is bad, losses tend to result. I'll provide an example in the futures market, which I hope will illustrate how an informed speculator can simultaneously provide a market service, provide an economic benefit, and make a profit.

Let's take a trader who is an expert in soybeans. One day, he discovers that, for cultural reasons, China buys significantly more soybeans in certain years. He verifies this through a variety of methods such as historical data, interviews with cultural experts, and mathematical models. Based on his analysis, he determines that current prices of soybean futures do not account for this phenomenon. He buys large amounts of soybean futures that expire next year. This drives up the price of soybeans by a moderate amount. A farmer who uses futures to lock-in prices in advance of planting, sees that, due to the recent price increase, he can lock in more profit if he changes his usual corn crop to a soybean crop. He sells soybean futures that expire at harvest time and plants soybeans. During the middle of growing season, traders for a Chinese food manufacturer start buying large quantities of soybean contracts to guarantee sufficient delivery after harvest. This drives up the price of soybeans by a large amount and provides an opportunity for our soybean trading expert to sell his contracts for a higher price than he bought them for.

Consider the net result of all this. A trader influenced farmers to increase supply in time to meet Chinese demand months into the future. As a result, 1) the farmers made more profit than if they had planted corn, 2) the Chinese manufacturer paid a lower price than if supply had been less, and 3) the market paid the trader a profit in return for his service.

Similar examples exist in all other markets and for all other types of valid trading.

This example illustrates one of the reasons why all major economies today have markets. Appropriately regulated markets help prioritize resources. This influences everything from production decisions to which companies should receive capital for expansion.

I think the common misperception that profitable speculation is impossible is because it is so difficult to do in today's highly competitive markets. It's similar to playing basketball for a Division I NCAA college team. Approximately 1% of high school basketball players go on to that level. That doesn't mean it's impossible, it just means that you probably don't know anyone who has done it and that unless you have a particular combination of skills, you probably shouldn't count on being able to do it either.