Learning-based trading strategies in the face of market manipulation

Abstract

We study learning-based trading strategies in markets where prices can be manipulated through spoofing: the practice of submitting spurious orders to mislead traders who use market information. To reduce the vulnerability of learning traders to such manipulation, we propose two variations based on the standard heuristic belief learning (HBL) trading strategy, which learns transaction probabilities from market activities observed in an order book. The first variation selectively ignores orders at certain price levels, particularly where spoof orders are likely to be placed. The second considers the full order book, but adjusts its limit order price to correct for bias in decisions based on the learned heuristic beliefs. We employ agent-based simulation to evaluate these variations on two criteria: effectiveness in non-manipulated markets and robustness against manipulation. Background traders can adopt the (non-learning) zero intelligence strategies or HBL, in its basic form or the two variations. We conduct empirical game-theoretic analysis upon simulated payoffs to derive approximate strategic equilibria, and compare equilibrium outcomes across a variety of trading environments. Results show that agents can strategically make use of the option to block orders to improve robustness against spoofing, while retaining a comparable competitiveness in non-manipulated markets. Our second HBL variation exhibits a general improvement over standard HBL, in markets with and without manipulation. Further explorations suggest that traders can enjoy both improved profitability and robustness by combining the two proposed variations.