Layering vs. Spoofing

Right, I understand that much. Do you know of any papers that talk about this in greater detail? The best I've been able to come up with is:

http://www.zerohedge.com/news/2013-07-23/watch-banned-hft-spoofing-algo…

Are there any other types of spoofing?

pioneer:

Spoofing is placing orders that are unlikely to trade in an attempt to trick algos into trading on the other side. As an example, say the inside market is 100.10 bid, offered at 100.20, 500 shares/contracts on each side.

You offer 100 shares at 100.19 and bid 1500 shares at 100.10. A lot of naive HFT and execution algos look for order book imbalances as a signal that the price will move in the short-term. The spoofer wants the algo to lift his 100.19 offer, at which point he'll cancel his massive 100.10 bid and try to buy back cheaper (he just got the algo to pay the spread when fair value is closer to the mid, so assume he can exit there most of the time). Since there are 500 shares in front of the fake bid, the spoofer can usually cancel his order before someone hits him for big size.

Layering is a spoofing tactic where rather than placing one large bid, the spoofer places several orders a few ticks apart to give the appearance of buying/selling interest on the book. This is more common on thin names where the top of book is only a few round lots or less, so beefing up the bid/ask at top of book is risky.

This is a very easy pattern for regulators to spot. A legitimate market making algo is going to leave its bid alone or make it more aggressive upon putting on a short position, not cancel it entirely, and it will usually quote similar sizes on both sides of the book when flat.

I'm not sure if this activity should be illegal to be honest. Automated strategies are often exploiting weaknesses of human traders showing their hand but it's apparently unfair for humans to exploit dumb hair-trigger algos that dump positions as soon as the market looks like it may go one tick against them.

A lot of uninformed people lump fast cancels by HFTs in with spoofing but that's something entirely different. HFTs are usually flickering prices because of changes in their pricing/risk model. As markets get more fragmented you see things like 100 shares trading on one market and every order at that price on other exchanges stepping away. That happens because the algo really only wants 100 shares but has to show it 20 different places to get flow.

What makes it illegal has nothing to do with who's exploiting who, it's simpler than that: you can't place market making orders if you have no intention to trade them. In a lot of obvious spoofing scenarios, it's pretty easy for the exchange to prove that they had no intention of trading those large or layered orders.

Ah ok, thanks for making that distinction.