Financial firms should be on the lookout for potential market manipulation as the spike in volatility and volumes driven by coronavirus concerns could embolden traders with bad intentions looking to “hide amongst the noise,” Nasdaq Inc said on Friday.
The U.S. stock market is on course for its worst month in three decades as fears of the severity of the pandemic have led to a massive sell-off, with the S&P 500 losing nearly 30%, or more than $8 trillion, in value since hitting a record closing high on Feb. 19.
As volumes spike, so do the number of trading surveillance alerts at financial firms, but surveillance analysts need to be vigilant and not assume that the rise is just a normal response to the increased market activity, two Nasdaq executives said in a post on the exchange operator’s website. Nasdaq is also a top provider of trading surveillance technology to exchanges, brokerages and regulators.
“Taking a historical approach to this idea, one could almost certainly expect to see one, if not multiple, cases of manipulation stemming from this period,” said Michael O’Brien, head of product management, risk and trade surveillance, and Alan Jukes, principal product manager of trade surveillance.
For example, during the “flash crash” of 2010, which briefly wiped out nearly $1 trillion of stock market value, several trading attributes of a UK-based day trader named Navinder Sarao were flagged as potential market abuse, but many went undetected by the executing brokers.
Years later, Sarao was shown to have used an automated trading program to “spoof” markets by generating large sell orders that pushed down prices. He then canceled those trades and bought contracts at lower prices, regulators and prosecutors said.
Among the red flags were the large number of canceled orders compared with entered orders that Sarao’s algorithms generated, the Nasdaq executives said. His orders were also modified far more often than other traders’ orders, and the ratio of canceled orders to trade executions, at about 99.7%, was well above average, they added.
“When taking a closer look, there are certain behaviors that stand out from the crowd during these times, and that is still observable – even in times of wild volumes and high volatility,” they said.