Algorithmic trading terrorism

Forbidden practices in High Frequency Trading

The definition of High-frequency trading varies depending on who you ask. However, all definitions share the following baseline: "HFT refers to the usage of automated strategies that place large quantities of orders very quickly."

Now, what kind of automated strategies are we going to discuss? As you probably noticed by the title, this post is about harmful and illegal ones, strategies that can hurt yourself (if you get caught) and others.

Spoofing

Probably the most known. It gained notoriety after the 2010 flash crash. The spoofer intends to create an illusion of fake market pressure by placing relatively large orders she doesn't intend to execute. For instance, say a spoofer has an initial long position. She then places large spoof buy orders she doesn't intend to get filled to trick unknowing market participants into placing buy orders supporting this fake demand. The spoofer then would sell her original position for a profit from the manipulated move and cancel the fake orders. Some people say spoofing is done just at the top of the book, and when it happens across many levels in the order book it's called layering.

Front running

Usually happens within brokerage firms. It involves having insider information about a client or market participant to place a large order and execute it before it hits the market. 

Quote stuffing

Refers to placing and canceling thousands of orders in time spans under a second to gain an advantage over slower market participants. Some people argue it's just a software error. Others say it's a tactic to widen the bid-ask spreads, making market participants pay higher costs when executing trades.

Quote dangling

Similar to quote stuffing, places a bait order between the spread to trick an unknowing trader into executing a market order against it. This fake order is quickly canceled and the unknowing trader gets filled at the next price level. There's a gray area when this bait order is small enough not to have any noticeable impact and the quote-dangler accomplishes the goal of getting filled at the next level where she may have larger orders at a cheaper price.

Wash trading

Occurs when assets are bought and sold by the same entity with the primary intention of increasing volume. With this technique, crypto exchanges may trick potential traders into thinking the exchange has good liquidity. In this paper, the authors claim that wash trading accounts for approximately 70% of the volume on most unregulated crypto exchanges.

Momentum ignition

Tries to incite explosive market moves. It works by placing a series of aggressive orders submitted in a short period to trigger stop orders resting at a certain level in the order book. The ignited price movement allows the aggressor to exit the position she already had before the manipulation started.

Pinning the close

May not be as known as the other ones. As the name says, it aims to pin the close of an instrument at a certain level. This strategy is usually employed to manipulate the payoff of option contracts. The aggressor may want to ensure the underlying trades at a specific price when the options she owns expire.

This is an educational post and does not encourage the use of any of the strategies mentioned.