Legal and Illegal Computerized Trading Strategies

Modern financial markets rely heavily on computerized trading systems. A computer can make thousands or even millions of trading decisions per hour. The legality of these trades depends on the trading strategy and intent behind the orders rather than the speed at which they are executed.

Legal Computerized Trading Strategies

1. Market Making

A trading algorithm continuously posts buy and sell orders and earns profits from the bid-ask spread. This activity provides liquidity to the market.

Example:

• Buy Microsoft shares at $500.00
• Sell Microsoft shares at $500.02
• Profit approximately $0.02 per share if both orders execute

2. Index Fund Rebalancing

Computers automatically adjust holdings to match an index such as the S&P 500.

Example:

• A company rises in index weighting
• The fund algorithm purchases additional shares
• The portfolio remains aligned with the benchmark

3. Statistical Arbitrage

A program identifies temporary pricing discrepancies between related securities and trades on the expectation that prices will normalize.

Example:

• Stock A and Stock B usually move together
• Stock A suddenly falls much more than Stock B
• The algorithm buys A and sells B
• The trade profits if the normal relationship returns

4. Trend Following

The system buys assets displaying upward momentum and sells assets showing downward momentum.

Example:

• Buy when the 50-day moving average rises above the 200-day moving average
• Sell when the reverse occurs

Illegal Computerized Trading Strategies

1. Spoofing

Large orders are entered with no intention of execution. The purpose is to create a false appearance of buying or selling interest.

Example:

• Place a buy order for 100,000 shares
• Other traders react to apparent demand
• The price rises
• The large order is canceled
• Existing holdings are sold at the artificially inflated price

2. Wash Trading

The same trader effectively trades with themselves to create fake volume and market activity.

Example:

• Account A sells shares
• Account B, controlled by the same trader, buys those shares
• No meaningful change in ownership occurs
• Volume appears higher than it really is

3. Layering

Multiple deceptive orders are placed at different price levels to manipulate market perception.

Example:

• The algorithm submits many large buy orders below market prices
• Investors interpret them as strong buying interest
• Prices move upward
• The deceptive orders are canceled

4. Automated Pump-and-Dump Schemes

Automated systems artificially drive up a thinly traded stock before selling holdings at the inflated price.

Example:

• A bot aggressively buys a small-cap stock
• The stock price rises sharply
• Promotional messages encourage public buying
• The operator sells shares into the rally

Key Principle

Market regulators generally do not limit trading based on speed alone. A computer may execute millions of legal trades. However, even a single trade can be illegal if it is intended to deceive other market participants, create a false market, or manipulate prices.