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It's alleged that Navinder Singh Sarao contributed to the flash crash by placing huge, fake, order for S&P Minis. Mr. Singh Sarao then cancelled the huge orders before they were filled. The spoofed orders created false impressions in the market which Mr. Singh then profited from.

Here's what I don't get...why weren't the fake orders filled, leaving him with a real position? Order execution is typically very fast so how was he able to show the fake order to the market then cancel it before it was executed? It seems like he was putting himself in a very risky position that the huge fake order might get executed.

Note: I realize spoofing is illegal and very risky in that sense. I'm trying to understand the positional financial risk aspect (not counting fines, legal fees, jail, etc.).

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This FT Alphaville article confirms and has some discussion about your idea that Sarao was indeed taking a risk every time he created spoofing orders. But in short, yes: if you place a limit order and a large enough order hits the market your limit order can be filled without a possibility to cancel (unless the exchange is dodgy) and you will end up with a position.

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  • $\begingroup$ In his defence, Mr. Sarao could argue that he was sometimes hit, so he wasn't a spoofer, and present evidence of that fact. We shall see. Personally I doubt that he was ever hit, or if he was it was in an exceptionally small number of cases, thanks to automated cancellation. $\endgroup$ – noob2 Oct 5 '15 at 18:07
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The reason these "fake" orders weren't filled was because they would be placed outside of the bid-ask spread. So, imagine the following: you're trying to buy/turnaround S&P 500 E-Mini futures to make a quick profit. The bid is 1976.50 and the ask is 1977.10. What you do is place a large sell order in the market for 1976.10 (or some price below bid) to make it look as if the market is bidding the asset down. You're hoping that this large volume causes the price to fall temporarily, but not enough so to cause your order to actually be filled. In a successful case, the bid falls (because of your large, below-market order) to 1976.20 (or whatever lower figure) causing the resulting ask to be lower as well. You then buy in at this lower ask and cancel your sell order at 1976.10. The strategy is that the price will return to its fair level with your low order now cancelled while you profit on the security you purchased at the artificially depressed price. You can go the opposite direction when it's time to sell and set a fake buy order above market, too.

Now the risk is when you place your aforementioned 1976.10 sell order, but the market conditions are such that this actually falls within the appropriate bid - ask range, causing the order to execute. This is risky because these fake orders are usually massive in volume, sometimes more than the trader can afford and almost always more than they should allocate. Thus, any small losses on this unintended position can prove disastrous. Additionally, these fake orders are in the opposite direction of the trader's actual bet.

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