A trading bot is a pre-programmed piece of software that makes automatic trades when a pre-arranged trigger has occurred. This trigger event can be, for example, when the share price falls below a certain price. This was the case in the 1987 Black Friday Wall Street market crash, where early generation trading bots sold stocks automatically when they fell below the set price, which contributed to a 22% fall in the index. So, we can see that trading bots have been around for a while, manipulating the short-term market as they were programmed. It is therefore not a surprise to hear that for as long as cryptocurrency has been traded, there have always been trading bots manipulating the market.
It is no secret that bots are all over the crypto worldwide market, due to it being poorly regulated. Even in developed countries like the US, Japan, and South Korea, there are no regulations that discourage unsavoury trading practices, which has contributed to the current situation. Together with the rapid expansion of the market and the huge influx of new and inexperienced traders looking to capitalise, trading bots are now prevalent across all cryptocurrency exchanges.
The primary way that cryptocurrencies, such as Bitcoin, is traded is through spread betting, via City Index, for example. This involves the investor looking at the current price of the coin, speculating the price movement, calculating the stake of the trade per price movement and finally closing the trade. The profit or loss is then calculated according to how the market shifted. Therefore, trading bots are potentially dangerous for investors conducting a crypto spread trade, as there is the real potential for the bots to distort movements in the market.
So how do these bots manipulate the market? One way is through artificially inflating the price of the coin, which leads inexperienced traders to overpay for the coins they are buying. This is an example of a pump and dump scheme. The pump is where bots purchase large quantities of the low-priced coin which rapidly increases the price of the coin. Once enough investors buy the coin at the inflated price the bots dump the coin, leaving investors perplexed as to how they lost their entire investment in a blink of an eye. These investors are usually new to the game, and because of the popularity and hype caused by the fast rise of the Bitcoin price, rush into a trade based on the Fear of Missing Out.
Market manipulation is not good for the future of cryptocurrency, with many speaking out against it. In the regulated financial market, such acts of market manipulation are illegal for a reason. The Securities and Exchange Commission has attributed this for the rejection of crypto-based Exchange Traded Funds.
As a trader, it is of paramount importance to be able to detect when bots are trading and manipulating prices. The two biggest indicators are price momentum and volume. When looking at these factors it is quite simple to identify when a flash crash is caused by normal human behaviour or through trading bot software. Identifying these patterns will enable investors to protect themselves from potential flash crashes and pump-and-dump schemes.