Your algorithm's market impact is your responsibility

Graduate · enrolled learners

This lesson opens with Navinder Sarao, 2010 to 2015.

What happened

Navinder Sarao was a lone trader operating automated trading software from his home near London, and his programs placed very large orders in stock-index futures that he did not intend to execute, canceling them before they could fill, in order to create a false impression of supply or demand and push prices in his favor, a manipulative pattern known as spoofing. He used a modified off-the-shelf trading platform to layer E-mini S&P 500 orders on more than 400 trading days from 2010, the CFTC alleged that he profited by more than 40 million dollars and that on 6 May 2010 his layering contributed to the extreme order book imbalance behind the Flash Crash. In April 2015 he was arrested at his London home, in November 2016 he pleaded guilty to one count of spoofing and one of wire fraud, and in January 2020 he was sentenced to time served and a year of home confinement; the US Department of Justice and the CFTC held him responsible for market manipulation. The orders were placed and canceled by an algorithm, not by hand, but that made no difference to his liability: automating the manipulation did not make it something other than manipulation, and running the software was a choice he owned. Nothing was hacked; a person built and ran a system whose deliberate effect on the market was illegal, and the law held the person, not the software, to account.

The decision point

An operator is responsible for what their algorithm does to the market, because the algorithm acts on the operator's behalf and by their design, so automating a behavior does not separate the operator from its consequences, legal or ethical, and 'the algorithm did it' is not a defense. Navinder Sarao is the case: automated software placed and canceled large orders to manipulate futures prices, and although a program did the placing, the DOJ and CFTC held the person who built and ran it responsible for market manipulation, because automating a manipulative pattern leaves it a manipulative pattern. The lesson for a systematic trader is that a system's market impact is a first-class concern, not a side effect: what the system does to prices, to other participants, and to the integrity of the market is the operator's responsibility to understand, monitor, and own, exactly as if they were doing it by hand, because in the eyes of the law and of good practice they are. This cuts two ways. A pattern that would be manipulation done manually, placing orders you intend to cancel to move the price, is still manipulation when a program does it, so building it into an algorithm is building a crime. And even a well-intentioned system can have a market impact the operator must watch, moving a thin market, and a responsible operator monitors that impact rather than treating the algorithm as an autonomous agent whose actions are not theirs. So the discipline is to treat the algorithm as an extension of the operator, to own its market impact fully, and never to let automation launder a behavior that would be wrong or illegal by hand, because Sarao is the reminder that the law reaches the person behind the software, and the software is only ever doing what its operator built it to do.

Orientation and Year One are open: anyone can read them without an account. From Year Two onward the lessons are for enrolled learners, because progress through the later years only means anything if it is tracked against a record.

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