The Dark (Pool) Truth About What Really Goes On In The Stock Market: Part 2

Tyler Durden's picture

Courtesy of the author, we present to our readers the following excerpt from Dark Pools: High-Speed Traders, AI Bandits, and the Threat to the Global Financial System, by Scott Patterson, author of The Quants. Part 1 can be found here.

Haim Bodek thought practically nonstop for days about what the trade-venue representative had told him that night at the New York party.
The way that the abusive order types worked made him think back to a document he’d been given by a colleague that summer as he researched what was going wrong at Trading Machines. The document was a detailed blueprint of a high-frequency method that was said to be popular in Chicago’s trading circles.

It was called the “0+ Scalping Strategy.”

Bodek suspected that there might be a link between the order types and the strategy.

Riffling through his files, he quickly found it. While the document didn’t say which firm used the strategy, he’d been told by the colleague who’d given it to him that one of the most successful high-speed firms employed it, or something closely akin to it. Due to the sophistication of the strategy, he’d guessed from the start that it was probably written by a Plumber.

There was another giveaway that it had originated in Chicago, where Bodek had worked for several years at Hull Trading: “scalping.” To a trader, scalping didn’t mean the same thing it meant to most people—a suspicious-looking guy peddling tickets for a sporting event or rock concert outside a stadium. In trading, scalping was an age-old strategy of buying low and selling high—very quickly. It was a common practice on the floors of futures exchanges that populated the Midwest—the Kansas City Board of Trade or the Chicago Mercantile Exchange. The 0+ Scalping Strategy was apparently a futures-trading technique that had been transformed into a computer program.

Bodek started reading. Page two of the document laid out the purpose of the 0+ strategy. “Simple Goal: use market depth and our order’s priority in the Q to create scalping opportunities where the loss on any one trade is limited to ‘0’ (exclusive of commissions).”

He paused at that. Essentially, the author of the strategy was saying that its primary goal was to never lose money—the loss on any trade was “0.” In theory, this could be done through a scalping strategy. By being first in the “Q”—shorthand for the queue in which orders are stacked up, like theatergoers waiting in line for their tickets—the firm could always get the best trade at the best time.

But what happened when the firm didn’t want to buy or sell? Bodek kept reading.

“GOAL RESTATEMENT: use the market depth and our order’s priority in the Q to create scalping opportunities where the probability of a +1 tic gain on any given trade is substantially greater than the probability of a –1 tic loss on any given trade.”

Aha, Bodek thought, market depth. That was a reference to the orders behind this firm’s orders, the other theatergoers waiting in line. The 0+ trader is assuming that his firm is so fast and so skilled that it can almost always get priority in the trading queue—be the first to buy and the first to sell. The depth behind it, the other orders, is the rest of the market.

The author is saying I always want to win (or rather, I never want to lose). His probability of winning—a +1 tick—is “substantially greater” than a –1 tick loss.

But how?

The rest of the market—suckers like Trading Machines or every- day mutual funds—was insurance. Under the next heading, called SIMPLE PREMISES, the exact meaning of what insurance meant was spelled out.

“If we have sufficient depth behind our order at a given price level, then we are effectively self-insured against losing money. Why? If we get elected on our order, we could immediately exit our risk for a scratch by trading against one of the orders behind us.”

In other words, if the 0+ trader buys a stock (gets “elected”), and his algos suddenly detect that the price is likely to fall—they can see a large number of sell orders stacking up in the trading queue—he can flip and sell to the sucker standing behind him, resulting in a “scratch” (no gain and no loss). He can do this because his computer systems can “react fast enough to changing market conditions . . . to ‘always’ achieve, in the worst-case, a scratch or a cancel of our orders.”

It was the Holy Grail of trading. The 0+ trader was describing a strategy that effectively never lost. The rest of the market protected it whenever the firm’s algorithms detected the slightest chance that the market was moving against it.

It’s brilliant—and diabolical. A firm that has found a strategy that is virtually guaranteed to win on every trade has discovered a hole in the market. Trading is all about taking risk, but this author was describing a virtually riskless trade.

The situation confronting Bodek and other investors not using the 0+ strategy was challenging, to say the least. It was like driving a car down the freeway, and every time you tried to speed up, another, faster car was in front of you. No matter how many tricks you pulled, this car (a 0+ symbol stamped on its hood, of course) was always leading the pack. The only time you could get around it—when it would suddenly hit the brakes and vanish in the crowd behind you—was when a Mack truck was speeding right at you. Worse, the 0+ trader was the Mack truck!
The upshot: Regular investors, the suckers using those stupid limit orders, buy high and sell low—all the time.

The game had changed. Bodek became increasingly convinced that the stock market—the United States stock market—was rigged. Exchanges appeared to be providing mechanisms to favored clients that allowed them to circumvent Reg NMS rules in ways that abused regular investors. It was complicated, a fact that helped hide the abuses, just as giant banks used complex mortgage trades to bilk clients out of billions, in the process triggering a global financial panic in 2008. Bodek wasn’t sure if it was an outright conspiracy or simply an ecosystem that had evolved to protect a single type of organism that had become critical to the survival of the pools themselves.

Whatever it was, he thought, it was wrong.

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veyron's picture

 “Simple Goal: use market depth and our order’s priority in the Q to create scalping opportunities where the loss on any one trade is limited to ‘0’ (exclusive of commissions).”


People still do this nowadays in ETF arbitrage (trading a basket of ETFs tracking a common index).  However, commissions in some cases actually do add up to something real.


For example, exchange fee (for taking liquidity) is generally 5-10 mils (hundredth of a cent per share) higher than exchange rebate (for adding liquidity)

Leopold B. Scotch's picture

My Atari 2600 could do this in 1982.

Precious's picture

If these securities Smirfs were not doing this, they would be in breadlines, because parasitic fucking off is all they know.

Zaydac's picture

Wrong. Such people are never in the breadline. If they were not doing this they would be running some other form of organised crime.

old naughty's picture

...and will still get away.

Such is the sorry state of our corrupt society.

Hunter S. Thompson's picture

It is not a ponzi scheme it is front running.

Precious's picture

Right.  They left out the paragraph on receiving a phone call from Bernanke.

rocker's picture

Wrong and Right, It is front running: act 1.  Then is is market manipulation: Act 2.    Ponzi: Act 3.

Mr. Lucky's picture

So it wasn't Waddell & Reed?

TalkToLind's picture

Just buy physical bullion, bitchez.  

zorba THE GREEK's picture

When the game becomes rigged, it's time to quit the game.

Missiondweller's picture

"The only winning move is not to play"

War Games, 1983




Precious's picture

Was that made in America too?

rocker's picture

Missiondweller is very smart. Let them bleed each other until they finally quit. It may take a long time.

world_debt_slave's picture

yep, my exit was around 2002 or 3

stocktivity's picture

I've been saying that for a long can't beat this rigged casino whether you're long or short. They'll get your money. It's all Bullshit!

RingToneDeaf's picture

Oh, come on, after all, it is all on the level.

zKeyserSoze's picture

Jim Grant: Central Banks are Waging War on Supply and Demand May 3rd, 2012 at 2.50 min.

Jim Chanos ‘China Makes Greece and Spain Look Like Child’s Play’  June 29,2012
Some Bloke's picture

My high speed trading method is to ring up my broker, ask him to buy me 100 XXX, but before he has done anything I cancel, and therefore never lose.  Why aren't I this book?

Hunter S. Thompson's picture

Heads we win, tails you lose strategy. Nice work if you can get it.

Precious's picture

America.  Land of the free (rider), and the home of the brave (insider).

indianajohns04's picture

Bought the book online decent read so far

Nid's picture

And for the past 8 months, give or take, these fucks have been able to creep this pathetic market upward, one tick at a time, because there is no traffic coming at them (btw, no doubt the CBs have among the fastest algos). When it finally does, they make a u turn and the we'll see 900 on the S&P.

Centurion9.41's picture

These firms don't create the capital, the Fed cabal via QE, rates & margin requirements do that.

The fact you think these guys do it shows you don't know what you are talking about.

Nid's picture

Hey doosh, do you know what a CB is?

Centurion9.41's picture

Doody, yes. But they don't HFT ORDERS U MORON.

FranSix's picture

The "riskless" trade is necessary to support trading schemes under the Black-Scholes options pricing model.  You are supposed to earn riskless profits by delta heding strategies because of their superior mathematics, but as it turns out, you have to run risks under the law to protect that notion.   To the extent that LIBOR is manipulated.  Its just that simple.

vft2212's picture

It's April 1998 the a/d line has peaked and you are spewing LTCM

q99x2's picture

One more for the 2020 nurnberg trials. They only get away with it until they can't. Then all hell breaks loose with them as the scapegoats.

Centurion9.41's picture

Though I believe the HFT shold be made illegal through some form of life requirement for an order to remain at a given level, e.g. 15 to 30 seconds, this article is so highly misleading it borders on lying.

If a customer has a limit order in, and that order is within the price range of say 90% of the price executions on that day, the order will be filled.

I know of firms that automatically fill retail client market orders at the NBBO if the order is for less than 500 shares & less than a certain capital value (basically excluding high priced stocks like BRK, GOOG, etc.). Even when only 100 is shown on the NBBO. In fact they do it automatically for multiple orders up until the firms position reaches a predetermined capital exposure, at which time the automatic computer execution ceases and the firm's trader/market maker must work the orders.

The fact is yes the HFT's raise/lower the price some, but certainly not to any degree that is significant to retail investors or traders.

That said, their impact on institutional trades and other hedge funds can become in absolute terms very significant relative to a retail investor/trader but is again insignificant relative to the other factors that effect performance.

The HFTs need to go to protect the market from another flash crash/1987 scenario. Not because they are significantly increasing the costs of the speculative game.

Like I said, they are mostly trading and transferring their capital between each other. But when the market is big, and the numbers huge, the absolute value numbers can make for great headline press.

Al Gorerhythm's picture


"The fact is yes the HFT's raise/lower the price some, but certainly not to any degree that is significant to retail investors or traders."

Please explain your statement in light of the May 2010 "Flash Crash" where the DOW lost 1000 poinnt in a nano sec only to regain those points in minutes. That was Ma and Pa Sixpack trading away in their basement, with limit orders, right?


Centurion9.41's picture

You obviously can not follow a distinction between the cost imparted to the market by paying an extremely fractionally higher price for a product vs the effect of a system on stability.

I flat out mentioned the flash crash. Limit order execution during those times are a function of liquidity. That is why I said "flash crash and 1987. If you were well versed in the crash of 1987 you would understand they were identical in cause and effect.

Both were created by computers being the primary order creators and the depth if both crashes were 100% a result of the long only money/institution, the true deep liquidity providers in the market -which are human driven trades, stepping back because they didn't understand what was driving the selling.

As for "mom & pop" traders, they #1 shouldnt be using limit sell orders sitting so far away afrom the market - it shows how hugely ignorant they are of how markets work and #2 anyone using limit orders in that fashion should understand the nature of liquidity as one moves further from the current market price - its called intelligence. If one is an ignoramus and walks out into the desert during a heat wave looking for water the reason they die is not due to the desert. It's their own stupidity that killed them.

Al Gorerhythm's picture

Everyone is blind when it comes to trading, even from their brokerage screen because all the screens we get to see are level 2 screens. If the "Market Makers" (program traders)  can write algorerhythms that are set of instructions that take advantage of external signals from the human traders, they are designed to create unlimited sell orders against the longs. The longs will get slaughtered regardless of their depth because they haven't the depth or speed to "Step back". The longs didn't step back, they were run over. The market didn't fall in a vacuum, nor because the longs stood back or sold taking profits. Bullshit. Someone lost a bundle and it was because of collusion. It wasn't the computer's fault. It was the instruction from the programmer, who took instructions from the CEOs of the world who profit from this collusion.


Centurion9.41's picture

There are clearly 8+ ZH'rs who either do not understand market mechanisms or simply refuse to look at reality objectively.

They probably, like the writer of this piece, we're not invited to join the team.

Al Gorerhythm's picture

Aha. And there you have it. You have to be invited.

chump666's picture

Rigged systems usually cannibalize themselves if ALL competition is eradicated  The stock market is no different.  If a casino is rigged, people don't bother betting (even casinos must allow some wins to attract customers.) In saying that the market is transfixed on the most refuted of scientific theories - determinism.  Central Banks believe they can control financial cycles (which are both effected by internal and external forces) - that is an impossible task.

Nothing will stop a chaotic reaction in the market, a small tremor that will be a f*cking wipe-out.  For me the beginning of that (apart from the European madness/Obama debt craziness and central bank lunacy), was the ETF liquidity problems that appeared on the TVIX a little while back, that and the JPMorgan derivative trade that is blowing out every month now + the LIBOR manipulation  = all leading to-something about to erupt from the stock market. 

As for HFTs.  Well they scalp on the 50/100 ma's.  It looks amateurish and pathetic.  When these things panic, which we are due for + all the other bs building up in the market, gonna be brutal.

vft2212's picture

For years my market orders have been "scalped" as in 2 cents here and a penny or 3 there for the worse. The only fight worth the effort is when the machines move simultaneously & the exchange forgets to cancel the NYSE # that drops to a penny in a nano second. You should see the bullshit response Margin Stanley copies and pastes when these occurences take place. Something like this "At the time your order was entered the NBBO ( Nat best bid & offer ) was blah blah blah. The real answer we all want is, Why is the US stock market at 13000?!?!. Forget these scumballs that "provide liquidity". The big picture is the answer I still do not understand.

Precious's picture

They are investing for the long term, like their good financial adviser told them to.

Cursive's picture


Stock trading switched entirely to decimal quotes in 2001 (pilot program launched in 2000).  While the 0+ strategy may have existed in some form or another prior to decimal trading, if we bring back stock trading in the eights, it would destroy HFT.

mick68's picture

I had a former wall street trader tell me about this years ago. This may be news today, but it's been going on a long time. Maybe without a computer program, but you don't need a program to do this, it just makes it easier.

Precious's picture

JP Morgan is actually using Amazon's Mechanical Turk.

Centurion9.41's picture

Yes, it's called stepping in front of an order.

The fact is it was far less dangerous for firms to do so before the tech/eTrade revolution when a customer had to call in on a phone to change an order (which is also why back then a good broker was worth his cost).

After eTrade when any retail moron could put-in/take-out orders via a click the risk on stepping ahead of an order greatly increased b/c the odds of it being cancelled on a whim grew.

So yea, this "cost" to a trade via stepping ahead by someone in the market has always been going on. And in fact now the cost is multiples less.

Decimilzation, which compressed the slippage cost on the spread went to virtually zero on a percentage basis for nationally listed stocks. HFT costs haven't even come close to returning transaction costs to that level.

HFTs r bad for mkt stability/orde due to effects during black & grey swans.
HFTs have not negatively effected costs during normal markets in a significant way.

That's the distinction.

world_debt_slave's picture

only good out of Chicago are it's hotdogs and pizza

MedicalQuack's picture

Good article and who knows what we will find when we uncover the code one day in some of these algos.  I kind of shudder when additional machine learning moves in as who knows what it will look like in a couple of years, if it survives:)

Cursive's picture

Two thoughts:

1.) Any trading or business strategy built on the assumption that it is risk free will eventually learn the fallacy of that thought; and

2.) "Zeroplus" would be a great handle on Zero Hedge.

mharry's picture

I kinda feel sorry for the fools who have their money with these criminals. I gently suggest to my customers that they shouldn't. Unfortunately they're blind sheep, like I was 3 months ago, before I found Zero Hedge.