The Dark (Pool) Truth About What Really Goes On In The Stock Market: Part 3

Tyler Durden's picture

Courtesy of the author, here is the last excerpt from the excellent Dark Pools: High-Speed Traders, AI Bandits, and the Threat to the Global Financial System, by Scott Patterson, author of The Quants. To read the previous excerpts, see here and here.

Haim Bodek rushed out the front door of his home, jumped in his all-black Mini Cooper, and sped to the train station in downtown Stamford, thrash metal pounding from the car’s speakers.

It was the morning of March 25, 2011, his last day on the payroll of Trading Machines. Bodek was scheduled to give a speech later that afternoon at Princeton University, at a conference called “Quant Trading: From the Flash Crash to Financial Reform.”

He was running late. He hadn’t written his speech yet, so he banged it out on his laptop on the train to Princeton.

It was hard. He wasn’t sure what to say. He’d grown so cynical about the market that he’d become convinced that massive reform was required. But he didn’t know if he should be the one to spearhead changing the rules of the game. He worried about his career, whether the new elite at the high-speed firms and exchanges who’d built the market’s digital plumbing in the past decade would attack him and make it hard if not impossible for him to build another trading operation. He had a wife and three young children to support, and he was out of a job. The role of market-reform gadfly wasn’t high on his list of priorities. But his creeping belief that the market had been hijacked kept bugging him, like a bee buzzing in his face. And it wouldn’t go away.

In his talk, Bodek went halfway in calling for major changes. He spoke about the structural issues facing the options market, the evolution of algorithmic trading, and the negative impact stock market structure changes were having on the options industry. There was no mention of toxic order types or 0+ scalping strategies. He wasn’t ready to take on the whole system—yet.

Bodek knew his complaints sounded like excuses for failure. Critics would say he couldn’t take the heat. But he was convinced there was more to it. Exchanges and high-frequency firms had been working hand in glove to design a system that gave an advantage to the speedsters. The speed traders had been working closely with the electronic pools for more than a decade, from Island to BRUT to Archipelago. They’d pushed for more speed, for more information, for new exotic order types. And the pools complied willingly.

It all added up.

In Bodek’s eyes, there was nothing implicitly wrong with what had happened—at least at first. The relationship between high-speed firms and exchanges was in ways beneficial for all investors, he thought. The Bots pushed for better execution. That made the markets better for everyone.

But a problem developed. High-frequency trading became so competitive that on a truly level playing field no one could make money operating at high volumes. Starting in 2008, there had been a frantic rush into the high-frequency gold mine at a time when nearly every other investment strategy on Wall Street was imploding. That competition was making it very hard for the firms to make a profit without using methods that Bodek viewed as seedy at best.

And so a complex system evolved to pick winners and losers. It was done through speed and exotic order types. If you didn’t know which orders to use, and when to use them, you lost nearly every time.  

To Bodek, it was fundamentally unfair—it was rigged. There were too many conflicts of interest, too many shared benefits between exchanges and the traders they catered to. Only the biggest, most sophisticated, connected firms in the world could win this race.

One apparent consequence of this hypercompetitive market was its fragility. Because high-speed traders were now competing for wafer-thin profits, they’d grown incredibly pain-averse. The slightest loss was unacceptable. Better to cut and run and trade another day. The result, of course, was the Flash Crash. It was an algorithmic tragedy of the commons, in which all players, acting in their self-interest, had spawned a systemically dangerous market that could threaten the global economy.

Bodek knew he’d made mistakes. He’d wasted months trying to hunt for a bug in the code of the Machine, when the problem was actually abusive order types.

Then he’d started using the order types himself to protect his firm from the abuses. But it felt dirty. He’d become one of the bad guys. One of the tipped-off insiders. Kill or be killed. He didn’t like it, but it had become a matter of survival.

It was not how the market should work. Investors should be re- warded for their intelligence, for being able to make accurate pre- dictions and take risk—not for knowing the location of secret holes inside the plumbing (or, worse, creating the holes).

That was Bodek’s biggest complaint: The Plumbers had won.

Finally, Bodek became determined to reveal what he believed was a corrupt insiders’ game that came at the expense of everyday investors. Was it outright collusion? He didn’t have enough hard information to know for certain. But he believed the exchanges were locked in cutthroat competition, not only with one another but with the dark pools and the internalizers like Citadel and Knight. It was a dynamic that went all the way back to the late 1990s when Island, Archipelago, Instinet, and other electronic networks were engaged in a kill-or-be-killed Darwinian struggle. That struggle led to massive innovation and changes and, to be sure, benefits for nearly all investors.

But something else had changed along the way. The competition had become toxic. The exchanges’ backs were against the wall, and they’d made a deal with the devil at the expense of regular investors.

And so in the summer of 2011, he decided to explain it all to federal regulators. He hired a major law firm to help him use his understanding of toxic order types he’d gained from his exchange contacts while at Trading Machines, combined with the details of his understanding of high-frequency strategies he’d learned from the 0+ Scalping Strategy document, to lay out a road map. The road map detailed his argument that high-speed traders and exchanges had created an unfair market that was hurting nearly all investors.

Were the regulators listening?

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holdbuysell's picture

"Were the regulators listening?"

Let me guess...a year later, nothing visible hints of change...I'd say a big fat no.

veyron's picture

There were changes: regulations were further loosened and new order types emerged.  

notbot's picture

My guess is they'll listen like they listened to Michael Burry: Audit him, send the FBI after him, make his life miserable.  Shoot the messenger

ACP's picture

Oh the regulators were listening all right. Listening to the people who manage their money.


JuicedGamma's picture

Too busy to be bothered, they were downloading porn.

Spirit Of Truth's picture

"Were the regulators listening?"

Yes.  Haim Bodek will be placed under house arrest in hours of this article being posted.

RockyRacoon's picture

If I were him I'd not take another plane ride, boat ride, go skiing, go snorkeling, go to the grocery store... or anything else.

Dr. Sandi's picture

Actually, Haim Bodek is really just the pen name of Jaime Dimon. The real Haim Bodek is this guy who used to pick on Dimon in gym class. Boy is HE going to be surprised.

Shigure's picture

Lol. Now cleaning coffee off screen.

exartizo's picture

"There were too many conflicts of interest, too many shared benefits between exchanges and the traders they catered to. Only the biggest, most sophisticated, connected firms in the world could win this race."


Great White sharks eat each other to survive.


Doña K's picture

If everyone of the 99ers stay out of the markets, we win. Take your money out of the markets mutual funds etc. as soon as possibe.

Cursive's picture



"The plumbers had won."


After all these years, we've finally discovered that we've been playing an elaborate game of Monopoly.

daveeemc2's picture

Funny, I learned as a kid how to play Monopoly - always be the banker.

Eventually an opponent would need to get up and take a #1 (better if it was #2)...and thats all you needed to stock pile your cash. And if there are multiple players in the game, shifting some hotels, cash kept em quiet.  What is unethical to a 14 year old kid?

Now Jamie Dimon isnt a 14 year old kid, and I wonder if he'd see anything wrong with this strategy, even as an adult?

Salt's picture

Guess they weren't the ones Nixon used.

spiral galaxy's picture

Tyler...........thanks very much for all that you do.  You have no idea the good you're doing for us low-life investors.


ghengis86's picture

I believe "muppets" is the parlance of our time (GS approved)

Dr.Engineer's picture

Those bastards.

This really impacts normal people who work hard, save, and try to build a nest egg.

They fear the people.  Now we must educate the people that they are being muppetized (a slow form of euthanasia).

I am a firm believer that if you have been given much, then much is required of you.  The strong must protect the weak.

How can we fight back?

CH1's picture

How can we fight back?

Stop feeding the system.

Stop obeying people you know are liars and thieves.

Build something better.

holdbuysell's picture

Think local/community. At a local level you can make a difference. And that's where it will make a difference and be most needed if things do go down in a bad way.

- Bank locally (credit union)

- Invest locally (businesses, community building efforts)

- Educate those around you (who are willing to listen)

ForTheWorld's picture

I'm learning more and more that this is a better way to go. While ever you're doing things outside of the place where you live, you can't improve said place. Make friends, build communities, be supportive and receive support of those around you.

Yes - it sounds idealistic, but that's because few have ideals any more - there's just more and more people with vices.

PrDtR's picture

Be prepared to DIE.. they will KILL you to keep YOUR MONEY!

disabledvet's picture

When last seen Arthur Levitt was fleeing the SEC to a Board position at Goldman an extra cool stint as a radio personality in the morning with Tom Keene! "They listened, they heard...THEY FLED!"..and wisely so.
I don't think you could put the SEC in the center of the Pentagon and "front and center in the war on terror" and still have it "resourced enough."

FlyinaRage's picture

This is a natural and systemic outcome of monetization. Money is a competition where the losers perish, and the winners make up the rules to suit themselves.There is no systemic reward for "good" behavior in a monetary system, only "bad" behaviors are reinforced. The reason corruption, pollution, warfare, scarcity and violence are so predominant in our culture is exactly because of this system, and no amount of laws and regulations will ever make competition fair. Humans are designed to cooperate and communicate effectively, only the monetary system stands in humanities way of progress and abundance. If you want to make things better, gain the knowledge of why this system is broken and what type of changes would be beneficial to human society. I would suggest reading "The Best That Money Can't Buy" by Jacque Fresco. Once you understand the root causes reinforced by culture, it becomes elementary to understand what has to change to improve society, and you will also be able to understand what is motivating the actions of the people around you.

Freewheelin Franklin's picture

Are you suggesting outlawing the use of money and/or currency? I can't tell if you are advocating the elimination of fiat money, or the elimination of all currency. 

RockyRacoon's picture

There is a large element of the tragedy of the commons in all this.  When money becomes a floating "asset" that is pooled and manipulated, the obligation to use it for the betterment of all is lost.  The so-called assets that are rehypothecated (and in many other areas of "investment") aren't really the funds of anyone who would be a good custodian and demonstrate a fiduciary position in its use and care.

Clint Liquor's picture

Today, lowest volume in over a decade.

I guess you really can't fuck all of the people, all of the time.

adr's picture

Yeah, well if you are a director who just got a grant of 30k shares and the low volume HFT meltup caused those shares to increase in value. You aren't going to care if the volume was 1 order.

I think that is really the case of what's going on.

ImnotPOTUS's picture

Why of course they listened, then a junior enforcement kid fresh out of college spoke up and said wouldn't it be simpler to impose a sliding capital gain tax that went higher exponentially to the inverse of the duration of time the security was held. Only seems fair. You hold a stock for 10 miliseconds you pay 99% tax, you hold for whole minute: 90%, you hold it for a whole 24 hours: 66%, you hold for 3 months: 40% etc .etc. Seems only fair. I mean, the whole point of the market is to allocate capital to it's best use, right?

The young boy was summarilly torn apart and devoured by his seniors as a lesson to others in the room.

ghengis86's picture

Fuckin A.

+1 to you good sir

rufusbird's picture

That is probably the most profound statement I have ever read on the internet. How many times have you read about the  bloated "Annualized Return" on some short term investment. Well apply the tax to the "Annualized Return" ...Make me laugh out loud...

saycheeeese's picture

The SOB's have won so far... A flash crash and orders are cancelled or..

adr's picture

What they did was create a system that echoes the US treasury/Fed relationship.

The market sets the values and the corprations print the currency, ie stock certificates. Directors granted themselves unlimited numbers of shares that the market, through HFT, virtually guranteed to go up in value. This created a win win for the market and the directors since there would always be a buyer for the stock, as long as it continued to increase in value.

True productive work took a backseat to stock manipulation. CEOs all clamoured to be on the boards of other corporations. The president of a fishing company would sit on the board of a software company, a greeting card guy on a car company. How any of these directors could possibly advise on a business they know nothing about is beyond me.

Advising on business was never the goal of course, it was all an I'll scratch yours if you scratch mine deal. To get rid of earned income as a primary source of wealth. Why create a company and work hard, only to be taxed to death. Just sit on a few boards and take a few hundred million per year in stock grants, barely taxed at all.

There is no business, just agreements to purchase inventory and shift it between publicly traded corporations, to make it look like business is going on. A shell game with billions of dollars in stock options at stake. A total scam, with the traders like Goldman 100% complicit. The more stock created, the more there is for them to make commisions on.

If you could isotope tag an entire shipment of goods, you'll probably find the majority gets shipped around 100 times. The brand company starts with it, sells it to a retailer, after short time on the shelf the retailer sells it to a closeout retailer, it doesn't sell and gets sold to an outlet of the original brand, which then gets shipped back to brand's warehouse only to be shipped to the first retailer again on a future order. Velocity of product, nothing is ever actually sold to a consmer but a lot of sales are booked.

Doña K's picture

It only works for so long. The system will implode soon. just stay out of the system. Let the machines trade with each other. Low volume and absence of shorting crashes markets.

Dr. Sandi's picture

Consider the economy as a lobster in an expensive restaurant.

Professionally prepared, it looks succulent from the outside. But when you dig past the shell, you notice all the shell is empty. The meat has been eaten by maggots.

Now the maggots are eating each other.

eddiebe's picture

See, that's just the problem. A year late, a few trillion short and no accountability anywhere near the top. All the verbiage is just empty calories.

Yen Cross's picture

 The Dark Pool.   Sounds and smells like I should start a "Septic Tank" cleaning company!

Tom Green Swedish's picture

There is no market now.  Just a bunch of computers trading stocks.

CustomersMan's picture


I remember many years ago, working as a broker getting various adverts that offered to fund an account of mine, with certain side agreements, to the tune of 1,10,25, $million$ for a given number of days, so that I could in turn use it to secure lines of credit for XXXXXX.00 $ amount.


It seemed shady, since it was not in fact my money, but would appear to be at least for a while on a series of statements that could be confirmed.

That was long ago and probably does not work today, but I'm getting the same uneasy feeling on the inside order entry systems, these guys know they're F***ing the investor all the time, in some shape or form.