A Warning About Algo Trading Gone Wild... From 1988

Tyler Durden's picture

I didn't start out with much interest in the stock market—though, like most people, I enjoy watching it go boom and crash. When it crashed on October 19, 1987, I happened to be hovering around the fortieth floor of One New York Plaza, the stock market trading and sales department of my then employer, Salomon Brothers. That was interesting. If you ever needed proof that even Wall Street insiders have no idea what's going to happen next on Wall Street, there it was. One moment all is well; the next, the value of the entire U.S. stock market has fallen 22.61 percent, and no one knows why. During the crash, some Wall Street brokers, to avoid the orders their customers wanted to place to sell stocks, simply declined to pick up their phones. It wasn't the first time that Wall Street people had discredited themselves, but this time the authorities responded by changing the rules—making it easier for computers to do the jobs done by those imperfect people. The 1987 stock market crash set in motion a process—weak at first, stronger over the years—that has ended with computers entirely replacing the people.

      - Michael Lewis, Flash Boys


While we welcome the recent surge in attention directed toward high frequency trading courtesy of Goldman's endorsement of what we said in 2009 even if with a 5 years delay (at least Michael Lewis got a book deal out of it), perhaps the biggest irony is that attention is once again completely misdirected.

Judging by the escalation in various probes and investigations by the FBI, the DOJ and, amusingly the SEC, the primary issue under focus is that of whether or not the market is "rigged", i.e., whether HFT is legal or not. Well, of course it is legal! After all that was the whole point of redoing Reg NMS in 2005 - so those who would soon become HFT billionaires and the financial backers of the HFT lobby, would get a stamp of approval by the various regulators and legislators, completely clueless about what they would usher into the world of trading, and thus a green light to engage in riskless frontrunning of orderflow. Frontrunning which scalps pennies and subpennies, billions and billions of times.

The red herring was also planted: "we provide liquidity", the 'Flash boys' screamed when we first shone a light on their practices in 2009, and are still screaming now that the entire world is looking at them, adding that only thanks to HFT have trade commissions collapsed to record lows, so it must be wonderful for the retail investors, right.

Wrong. Because not only does HFT not provide liquidity when it merely frontruns big order blocks, and all the other time churns hollow quotes with zero intention to execute but merely gauges how all the other HFT algos in the market operate leading to an unprecedented explosion in quote stuffing, layering and churn which together with the complete inability of HFT to provide real liquidity - or take prop risk with limit orders against the trend when there is no bid block to fruntrun - was also the reason for the May 2010 flash crash when the market literally went bidless for several seconds, but the reason why trading has gotten so cheap is that indicated HFT liquidity is a mirage with zero order book depth: something all the major institutions have realized and have long since moved to dark pools when intending to trade large orders.

In fact, the only reason the bid/ask spread has collapsed as much as it has, is because the retail investor is the last hope of the dying "lit" (and rigged) markets, which have nearly cannibalized themselves out of all profitability if not existence (there is a reason why there has been an unprecedented surge in exchange M&A in the past three years), and exchanges are hoping to make up in volume ("oh look how cheap trading has become") what they will never regain in hefty fees. To be sure, commission-free stock trading is coming next in the last desperate attempt to lure the retail sucker who still hopes to "get rich quick" despite a rigged market. Of course, this simply means that equities will soon join the world of FX and bond traders, where there are no commissions, but simply a bid/ask spread. Perhaps we should look to the certifiably rigged FX market to see what a bang up job HFT has done in "lowering transaction costs" there too?

Which brings us to the topic at hand, because it is not whether or not frontrunning by HFTs is legal - it certainly is based on current laws - but what the trade off is to a market in which, as Michael Lewis correctly observes, computers have entirely replaced the people.

The answer is simple - unprecedented fragmentation and instability: a market that is not only rigged, but far worse: completely broken.

Irony points that it was the same Shearson that was making millions with "program trading" when everyone was enjoying the ride up and only saw it fit to "warn" about electronic trading after the event that saw a quarter of the entire market cap wiped out in hours (sorry HFT - you too will be the scapegoat after the next crash, as we laid out previously).

Double irony bonus points that it is this same Shearson Lehman Hutton whose well-known spin off would, some 20 years later, nearly cause the end of western civilization as Hank Paulson's 3-page term sheet knows it.

Triple irony, of course, is reserved for the fact that it is now none other than Goldman Sachs which is stepping into the shoes of Shearson Lehman and warning the world about the dangers that are looming unless market structure isn't promptly overhauled.

h/t @Dvolatility

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TeamDepends's picture

No wonder Lehman had to assume the position.

TaperProof's picture

I was the lucky owner of LEH puts and also short some stock when it went bye bye.  Those were good times.

SafelyGraze's picture

thank you, "Shearson Lehman Hutton an American Express Company".

thank you for your integrity.

I would like for you to manage my accounts.

what is the best number to reach you.

Kitler's picture


Area code Hellfire 911.

TaperProof's picture

kitler, can i have a link to the full size version of your pic?  Want.

shanearthur's picture

Just heard Ric Edelman on his radio show today saying how Lewis' book amounted to yellow journalism.

He said that since HFT deals with a penny here and a penny there it is practically irrelevant to average investors. He said the HFT guys may make a penny selling stocks, but they'll reduce the price by a penny when they buy, so that's why stocks aren't $1 million dollars each due to HFT guys running up the price. Why it's capitalist equilibrium in action! I couldn't believe my ears.

The way I see it is the HFT guys make a penny when selling and they save a penny when buying. The average investor looses a penny when selling and looses a penny when buying so there's no equilibrium as Ric Edelman would have one believe. He should know that the compounding interest on all those pennies adds up and the average investor needs those pennies, yet there he was glossing over this shit and basically lying in my opinion. Totally lost respect for that guy.

ebworthen's picture

Edelman, the scheister, talking his book.

Most pundits on the air amount to pacifiers for individual investors so they can steal their lollipops.

spekulatn's picture


Journalism, in the ideal world, is supposed to inform the citizenry of facts important to their well being. Modern journalism seems to involve issuing press releases from the oligarchical reptiles who are destroying Western Civilization. Maybe I am a naive fool, and it was always thus. Either way, Michael Lewis’s latest book lends credence to the view that he is a very modern journalist.


To give you a sense of scale: the largest HFT firm I know of, KCG,has operating cash flows of $140 million a year and a  modest market cap of $1.4 billion (betcha didn’t know it was a publicly traded company: Lewis certainly doesn’t mention it).JPMhas operating cash flows of  $100 billion a year, almost a trillion on the balance sheets, and a quarter trillion or so in market cap. David Einhorn ispersonallyworth $1.25 billion dollars. KCG’s entire market cap is only slightly more than that, and it employs 1200 people. Yet, somehow the HFT firms are the evil establishment, and JPM and Einhorn are … the plucky underdogs standing up for truth, justice and market makers not changing their quotes when some reptilian oligarch dumps 200,000 shares ofYoyoDyneon the market.

Yeah, I might believe that. I might believe that if I were a dribbling retard.


Finally my favorite part


Doing a bit of investigation into who owns IEX: we have the $13.2 billion  activist shareholder fund Pershing Square,owned by Bill Ackman, another “underdog” worth $1.2 billion. We have the $6.7 billion Senator Investment Group.Scoggin Capital is only worth $1.8 billion; they do distressed debt and mergers, and have managed to only have one down year in 25. Another investor is venture capitalist  Jim Clark, net worth $1.4 billion. He is particularly noteworthy as being a pal of Michael Lewis, and almost certainly the guy who made the introductions to the “flash boys” at IEX. Brandes Investment Partners is an old $29 billion AUM politically influential money management firm doing value investments, and is run by another billionaire. Third point, a hedge fund with $15 billion, also working in special situations aka “distressed debt and mergers,” run by the legendary Danny Loeb (who also has only one down year). Another investor in IEX is a little place called  Capital Group Companies, the biggest buy side investors in the world, with $1.15 trillion AUM. Capital Group has been more or less scientifically proven to be one of the most powerful and influential corporations in the world.

You get the idea: IEX is not owned by plucky underdogs. It is owned by very rich and powerful “buy side” people. People who find the present system of liquidity provision inconvenient.  Buy side has always found liquidity providers inconvenient; they had to pay old school “sell side” traders like Katusyama to work the trades for them at the very least. There wasn’t much they could do about it until now. Now that they own  almost everything, they can open their own damn stock exchange and buy some cheap brokerage flow. That and unleash Michael Lewis, the FBI and New York Attourney General on the peasants who make them pay for liquidity.



The whole piece is worth a read. Damn digital dickweeds are a real pain in the A$$.



Oldwood's picture

In the end, we know the whole damn thing is corrupt. for many of us we rally at any suggestion of justice in it, even if it is false or irrelevant. Ultimately, if government is involved, it is to use threats, real or imaginary, as a tool for further centralization of their corruption. Nothing good will come of this...it can't.

TaperProof's picture

I think the plug is going to be pulled on HFT.. perhaps after Goldman corners the market and profits with IEX for a couple years?    Or at least until the next major market crash.

ebworthen's picture

Formerly E.F. Hutton, formerly listened to:


Bought by Shearson/Leahman, then sold to Citigroup, now a part of Margin Stanley.

The original being revived by Hutton's Grandsons in 2012.

But yeah, 1988, after the '87 crash.

Nothing has changed.

Rigged Ponzi.

Yen Cross's picture

  Ebbie, wow, your post brings back memories... Well done.

falak pema's picture

Just goes to show its not a question of mechanics and technology but of mindset. 

"Do whatever it takes for the show to go on, without blips. Some wars cannot be trusted to the Wermacht generals; they require a Fuhrer and a Fuhrer's mindset to run it when the going get serious!"

Alexander, Caesar, Napoleon, Hitler... and all those who ran Pax Americana like Caesars right into "ground zero" ! 

Yen Cross's picture

 @ falek pema. I couldn't agree more. In most instances of great discoveries, there was great turmoil.

  Who knows actually/truly  who the "progenitor" of that skill or invention was?

bam's picture

hahaha love that commerical

Doom and Dust's picture

The big boys came late to the HFT party, according to Lewis' book, and when they came didn't prove particularly apt at computational competition.

Which makes me wonder, why are the tbtfuckers suddenly alligned? Why are we just now discussing practices that have gone on for at least seven years?

There are no heroes in our current oligopolistic, plutocratic nightmare. Only idiots and incontinents.

fonzannoon's picture

Everyone get some beers in the fridge and get ready for the big ABN Amro banker suicide thread tonight


McMolotov's picture

It's time to put aside our emotions and have an honest discussion about nail-gun control.

fonzannoon's picture

It's too late. You can change the laws all you want  but Americans have spent years loading up on nail guns. Chris Rock said we should raise the price of a nail to $5,000. That's the only way to stop this.

McMolotov's picture

Nail-gun culture is the real problem. We have to find a way to deal with these bitter people who cling to their nail-guns.

Make love, not houses. Squeeze boobs, not triggers.

fonzannoon's picture

Everyone in Alaska and Texas walks around town with their nail guns and you never hear about people getting framed to their sheetrock over there, do you? So take your "culture" argument and stuff it. It's people like that give the housing sector a bad name.

itstippy's picture

It's the rapid-fire pneumatic nail guns with high capacity magazines that cause most of the problems.  Our country's framers had Swingline 101 spring operated manual staple guns when they guaranteed the right of citizens to own them.

That said, I've got a Bostich F28WW bump feed that's a real tack driver.  It's too late to go back now.


MontgomeryScott's picture

I was at Home Depot today, and they have stopped selling nails in packages larger than 7. I set all 38 packages on the checkout counter. They wanted to see my nail purchase permit. I had my wife show them her nails (she does her own, and is a good manicurist), and they all panicked (ten fingers, ten nails). I tried to explain to them that I had to go to work every day so that wifey could go buy all the stuff to do HER nails, and they called the Home Depot resource officer over, and he was packing a nail-gun that fires two at a time, with wires attached, and it kind of crackled when my wife went down and started flopping like a flounder, right there at the checkout.

Next time, I'm going in armed. Does anyone know a place where I can get a night-vision scope for my nail gun?

I'm still bleeding from the nail assault on my back after we got home. I was pretty fired up, you know, and so was she...

Skateboarder's picture

If a banker commits suicide by tying himself up and beating himself up to a pulp (in that order), will we ban rope?

HungryPorkChop's picture

Nail guns don't kill.  It's the air compressors behind the scene doing the dirty work.  We should immediately finger print and do background checks of anyone wanting to purchase one of those high pressure air compressors.  After all, that's the real culprit!! Now go try and frame a house, Bubba!

e_goldstein's picture

A compressor free Amerika, for the safety of our banksters and their children.

Bryan's picture

I think we need legislation to limit nail guns to 7 OR LESS nails per magazine.  We'll get Schumer on this right away.

ShrNfr's picture

Somehow, going back to the market where you had to both sell and buy NASD stocks via a market maker and get a 25 cent spread for your trouble leaves me unimpressed too.

goBackToSleep's picture

I just had to make a shirt to commemorate peak Algo........


Yen Cross's picture

    Spys "r" us needs some moar polonium.   Only inquire if under 210.

  Contact : Jonny "quik death" OpduKa.   777-No-idea.

Mediocritas's picture

Eric Hunsader hit the nail on the head when he summed the situation up as "the value of a quote is becoming zero", or something to that effect. He's right. When quotes have no meaning, when there is no persistance of real positions in the book, then shocking price movements are inevitable.

Nanex has been demonstrating such events in individual issues again and again, must be hundreds of reports by now. Only a matter of time before the big one hits.

Measuring liquidity by spreads alone is totally wrong. The argument we're all making around here is that hollow quotes are an illusion of liquidity. Without real, persistent and abundant quotes in the book, it doesn't take much of a rattle to go dark with ZERO liquidity again. ZH (with naxex, themis, etc) deserves cred for being the leader in pointing this out.

Going to coin a new term here and say that "macro" quotes are MIA (outside of dark pools anyway ), having been replaced with robot "micro" quotes. Micro in duration, size, solidity, and meaning. True liquidity is demonstrated by a relatively high macro : micro ratio, providing resistance against flash smashes and flash crashes, after all, it's only in the times of shock that liquidity is really important, not when everything is CAVOK.

The HFT shops claiming they are great liquidity providers during normal trading is equivalent to a security firm saying it is providing security because its guards stand around looking tough, yet they run away as soon as a threat manifests. What the hell kind of security / liquidity is that?

buzzsaw99's picture

the market will never be allowed to crash. what hft will be blamed for is the scarcity of trading volume which cuts into the big boyz profits. it won't matter if the joo bankers crucify hft, volume is never coming back because by now everyone knows that the markets are just a big ripoff and there is no value anywhere.

MontgomeryScott's picture

Let's count, shall we?






Of course, there are other markets in the world, and other dates.

The market MAY not crash, again. It might simply CEASE TO EXIST.

HFT IS the 'joo bankers'. i think that your logic is quite backwards on this one.

In fact, the whole 'HFT' thing is NOT the problem, here. It's the FRONT-RUNNING via HFT that is the issue.

I see you want to buy some milk at the supermarket. Sorry, I just bought ALL of it a fraction of a second before your order went in. If you still want some, however, I'll sell it to you (of course, with a small consideration for myself).

Like any other tool, computers can be used to allow mankind to reach the stars (or steal everything from the poplulation). It's the honor and the fortitude of those who have the tools that decides how they are used.

I GOTTA downvote your comment. (It's not 'joos', by the way. think totalitarian Zionist masters, and the sheep that falsely worship them.)

oooBooo's picture

All this concentration on the tools and techniques of trading avoids examination of the core ways the stock and commodity markets are rigged and gamed. HFT and the rest make for easy scape goats to focus the public on while preserving the status-quo game. 



orangegeek's picture

there's limit down "kill switches" that were brought into play a few years ago


HFT algos scoop orders (somewhat illegal), but tighten spreads - tighter spreads hurts those fat institutions who's message is, "give your money to us, because you aren't skilled enough and never will be".


here's the reality - the only real hurt is to the institutions who's technology is inferior, so rather than fix it, they run their "entitlement yaps" to the media who is only too happy to create the campaign.



noob's picture

Soylent Green Is People!!!

bugs_'s picture

When E.F. Hutton talks, people listen.

ThirdCoastSurfer's picture

TD Ameritrade Client Agreement
8. Brokerage Services D) Payment for Order Flow

(TD Ameritrade) may receive remuneration from markets for directing order flow to them*... Markets may act as principals to buy, sell or hold securities for their own accounts, and they may make money while executing your trade.

*From $.002 to $.0035 cents per share to Direct Edge, Citadel and Citigroup.

MontgomeryScott's picture

Any time you enter in to an agreement, without contravening the terms, you are putting yourself fully at the mercy of the offering party.

IF you had walked in to TD Ameritrade's offices with a breifcase that had several million fedscrips in it, and opened it up, as you took their unsigned contract and stated, 'let's negotiate the terms', as you struck through several clauses (such as this one), and they had agreed to your changes (of course, all initialed, witnessed, and signed by both parties), you might have had an opportunity to speak out against these practices; perhaps even taking them to a civil court for breaking the agreement.

Since you were not in the position to do so (I assume), you agreed to their terms (I also must assume).

Did they keep their promise to only put the tip in? You agreed to let them do just that.

HELL, they front-ran you before you even SIGNED UP!

Isn't Citadel the corporation that operates several thousand broadcasting media markets on the AM and FM stations? How do you like 'donating' to their 'news' stuff? The 'rescue of Jessica Lynch', and the 'mobile WMD trailers' and the 'Fort Hood Shooting' (both parts) require MONEY to broadcast in hypnotic rythmn to the masses. I mean, the coverage of MH370 in itself requires an ongoing influx of 2 or 3 cents every trade; just to keep the studio lights on! If you factor in the hair dstylists, the 'lighting and gaffing' union workers, the salaries of the 'hosts'...

I gotta get the link to TD Ameritrade from you. It looks like the Ruskies are trying to take over Europe, and I don't want to miss a single thing! I'll buy and sell all day with them, if it means that they will make sure that those who keep me informed, keep me INFORMED!

MERKUH! FUCK YEAH! I'll just go shopping now, like GW said, and go over to the MERKUH healthcare sight now...

Lumberjack's picture
Dark markets may be more harmful than high-frequency trading



(Reuters) - Fears that high-speed traders have been rigging the U.S. stock market went mainstream last week thanks to allegations in a book by financial author Michael Lewis, but there may be a more serious threat to investors: the increasing amount of trading that happens outside of exchanges.

Some former regulators and academics say so much trading is now happening away from exchanges that publicly quoted prices for stocks on exchanges may no longer properly reflect where the market is. And this problem could cost investors far more money than any shenanigans related to high frequency trading.

When the average investor, or even a big portfolio manager, tries to buy or sell shares now, the trade is often matched up with another order by a dealer in a so-called "dark pool," or another alternative to exchanges.


Those whose trade never makes it to an exchange can benefit as the broker avoids paying an exchange trading fee, taking cost out of the process. Investors with large orders can also more easily disguise what they are doing, reducing the danger that others will hear what they are doing and take advantage of them...


...Top internalizers include units of KCG Holdings (KCG.N), Citadel, UBS (UBSN.VX), and Citigroup (C.N). Dark pool operators include Credit Suisse (CSGN.VX) and Morgan Stanley(MS.N). All of the firms declined to comment, or did not respond to requests for comment for this story.


With the incentive to use the public market eroding, many traders increasingly see exchanges, which are often described as "lit" markets because of the pricing transparency, as battlegrounds for high frequency traders, said Rhodri Pierce, of the CFA institute.


The result is an increasingly splintered market.


"So much of the U.S. equity order flow is in now in the dark, or siphoned off, that it never hits the lit exchanges, and there is just a lot less in the way of trading opportunities," said Mark Gorton, CEO of high frequency trading firm Tower Research Capital LLC.


In an attempt to win back some of the retail orders, exchanges such as IntercontinentalExchange Group's (ICE.N) New York Stock Exchange, Nasdaq OMX Group (NDAQ.O), and BATS Global Markets, have allowed brokerages to place dark pool-style orders on their platforms, with the trade hidden until after it is executed. NYSE, Nasdaq, and BATS declined to comment.



Lumberjack's picture

An old friend of mine who retired from writing, published this awhile back. I thought in light of what's going on it deserved a mention and provides some good background.


PBS Frontline: The Warning -- How Greenspan, Summers & Rubin Conspired To Silence Derivatives Whistleblower Brooksley Born (Complete VIDEO)