Quote stuffing is the practice of quickly entering and then withdrawing large orders in an attempt to flood the market with quotes and cause competitors to lose time in processing them.
The goal of quote stuffing is to gain a pricing edge over competitors as it causes them to lose time in processing these orders.
Quote stuffing was initially blamed as one of the main drivers of the 2010 “flash crash,” which led the Dow Jones Industrial Average (DJIA) to fall 1,000 points within minutes.
Quote stuffing, a term first coined by Eric Scott Hunsader, the founder of financial data company Nanex, is a strategy that high-frequency traders use to gain a pricing edge over competitors.
It is made possible by high-frequency trading (HFT) programs that can execute market actions with incredible speed–generating hundreds or thousands of orders per second. These programs allow HFTs to make money by arbitrage: exploiting temporary pricing inefficiencies before others have time to notice and/or react to them.
According to Nasdaq, HFT is estimated to account for at least 50% of total market volume. HFT in and of itself is not illegal. However, stuffing takes place when traders fraudulently use algorithmic trading tools to overwhelm markets by slowing down an exchange’s resources with buy and sell orders in securities.
Only market makers and other large players in the market are capable of executing these tactics since they require a direct link to the securities exchanges in order to be effective. This business is all about speed and the closer a HFT server is to the exchange, the quicker they can react to new information.
Quote stuffing has come under scrutiny from financial industry regulators, including the Securities and Exchange Commission (SEC), the Commodities and Futures Trading Commission (CFTC), and the Financial Industry Regulatory Authority (FINRA). All three regulating bodies have imposed fines on HFTs for violations of exchange rules, including quote stuffing, front-running, and price and market manipulation.
Though the SEC’s investigation ultimately placed the cause on other factors, quote stuffing was initially blamed as one of the main drivers of the 2010 “flash crash,” which led the Dow Jones Industrial Average (DJIA) to fall 1,000 points within minutes. Whatever the cause, it is reported to have been widespread and causing negative impacts on securities exchanges’ efficiency.
Additionally, research studies compiled by ResearchGate, Nanex, and the CFA Institute, among others, suggest that HFT practices, including quote stuffing, raise prices, decrease liquidity, and cause greater volatility in markets.
Both the New York Stock Exchange (NYSE) and FINRA adopted rule changes to address quote stuffing, including Rule 5210 (Publication of Transactions and Quotations) to prohibit “two types of quoting and trading activity that are deemed to be disruptive.” Other proposals to address the problem and reduce the advantage of HFTs include instituting minimum time periods, measured in milliseconds, before buy or sell quotes could be canceled.