The Dark (Pool) Truth About What Really Goes On In The Stock Market: Part 4

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.

In the dark dawn hours of yet another frigid New York morning, Josh Levine dressed quickly and left his apartment in the shadow of the Twin Towers at Battery Park. He trudged through city blocks clogged with treacherous mounds of packed dirt-pocked snow and ice from the year’s record-breaking string of storms. It was February 16, 1996. A Friday. Earlier that week, IBM’s AI supercomputer Deep Blue defeated world chess champion Garry Kasparov for the first time. Bill Clinton was entering his second term in office. The country was in the midst of a powerful economic boom that would culminate in a massive tech-stock bubble, and Levine and Datek’s army of traders would be at the center of it.

The programmer walked east on Wall Street, then turned south on Broad, passing by the marble façade of the NYSE. At 50 Broad, he took the elevator to the sixth floor and walked past a few early risers, the wired, sunken-eyed day traders for Datek. Staring at their computer terminals, hugging their steaming coffees, waiting impatiently for the action to start at the opening bell, they nodded to Levine quietly as he passed.

Months earlier, Levine had decamped from the tiny cluttered room on the tenth floor of 50 Broad to a larger room on the sixth.

The room quickly slouched toward the en- tropic chaos Levine seemed to thrive in. He brought in an inflatable kiddie pool and populated it with turtles. He grew sea monkeys in a glass jar. An Israeli army bazooka leaned in a corner. The ubiquitous garbage piles, the tech ’zines such as PC World, stacks of computer books, pizza boxes, magazines, crunched Coke cans, crumpled computer printout paper, and candy wrappers rose to the ceiling like tropical plants, competing for space with the baker’s racks of computers, rows of computer terminals lined up on card tables, electric cords and creeping cables shooting out of the floor and through holes in the ceiling.

Levine shed his jacket, sat down before his monitor, and hit a but- ton. His computer hummed awake. It was time. The pieces were in place. Now he was about to bring to life the heretical idea that he’d been nurturing ever since he was a teenage runner in the 1980s.
Typing rapidly, he called up the program. Inputting a few instructions and taking a deep breath, he turned it on. Island was alive.

“Island is here!” Levine wrote on Watcher News. “You now have the ability to execute Island orders from the safety and comfort of your own Watcher.”

Wall Street would never be the same.
One of the earliest Island clients was a secretive, highly successful hedge fund based on Long Island called Renaissance Technologies. At first, Renaissance’s programmers—the firm was entirely run by mathematicians, scientists, and computer wonks—were dubious of Island. The reason: Datek. They were suspicious that the Datek bandits were secretly watching Island’s flow and front-running it.

But Island proved too big to ignore. One day in the late 1990s, several of Renaissance’s top executives, including a pair of AI experts who’d formerly worked at IBM, Peter Brown and Bob Mercer, paid a visit to 50 Broad. They were bemused by the giant lizard, the pool full of turtles, the trash. Renaissance’s headquarters in East Setauket, Long Island, were as pristine as an Ivy League campus. More than anything, Brown and Mercer were deeply impressed by Levine, whom they instantly realized was a programming genius with a profound understanding of the market’s plumbing.

Renaissance deployed cutting-edge AI programs to build its models and guide its trading. But Renaissance’s AI was an evolutionary leap beyond what any other firm had ever attempted, creating a strategy that would turn Renaissance into the most profitable trading machine in the world, with annual returns averaging north of 40 percent a year. Island’s high-speed platform was an ideal match for its strategies.

The Island-Renaissance fusion was a vision of the future in which high-speed AI-guided robots would operate on lightning-fast electronic pools, controlling the daily ebb and flow of the market. The AI Bots poured their valuable liquidity into Island, which, in turn, made it possible for the Bots to operate at high frequencies. They fed off one another, creating a virtuous cycle that would become un- stoppable. Little-known outfits such as Timber Hill, Tradebot, RGM, and Getco would soon start trading on Island, forming the emergent ganglia of a new space-age trading organism driven by machines. Tricked-out artificial intelligence systems designed to scope out hid- den pockets in the market where they could ply their trades powered many of these systems.

In the process, the very structure of how the U.S. stock market worked would shift to meet the endless needs of the Bots. The human middlemen, though they didn’t know it, were being phased out, doomed as dinosaurs. And the machines were breeding more machines in an endless cycle of innovation, as programmers pushed the boundaries of speed more ruthlessly than Olympic sprinters. Trading algorithms would mutate, grow, and evolve, feeding off one another like evolving species in a vast and growing digital pool.

In the 1990s, that future had been inconceivable to all but a few visionaries—such as Levine, who had a bird’s-eye view of the market as it evolved. But in an ironic twist, what the market would evolve into would be a market far darker than anything Levine could ever have imagined—a market dominated by secret trading algos, vast data centers, and dozens upon dozens of dark pools.
Because the market was so dark, conspiracy theories became rampant. Rumors spread that some firms were sending waves of orders to jam up exchange matching engines—the core computers that paired up buy and sell orders—hoping to profit on discrepancies in prices across multiple pools. Sophisticated tricks known as “layering,” “spoofing,” and “quote stuffing,” in which computers gamed the electronic pools with phantom orders, were said to be unbridled. Insiders talked of trading outfits based in countries such as China, India, and Russia that manipulated prices around the world through sophisticated computer games.

Neil Johnson, a University of Miami physicist who studies complex market patterns, warned in a February 2012 interview of a “global war between competing computer algorithms” that could cause a “big system wide collapse” in which the stock market shatters like broken glass. The market, he said, had evolved into a “lake full of different types of piranhas” devouring one another in a high-speed frenzy. In a working paper he co-authored—“Financial black swans driven by ultrafast machine ecology”—Johnson showed that the market in the past few years had undergone “an abrupt systemwide transition from a mixed human-machine phase to a new all-machine phase characterized by frequent black swan events with ultrafast durations.”

It was a brave new world that few people outside Wall Street knew existed. The Algo Wars were leaving a path of destruction in their wake. And what about the Securities and Exchange Commission? The nation’s top stock-market cops were clearly outgunned. In May 2011, SEC Chairman Mary Schapiro told Congress that “the Commission’s tools for collecting data and surveilling our markets are wholly inadequate to the task of overseeing the largest equity markets in the world.”

It was as if the FBI were admitting that it couldn’t track organized crime. Everyone, it seemed, was in the dark.

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mammoth mo's picture

Well everyone was in the dark until the government decided to use the algos to their advantage and the individuals disadvantage.


After all - if people are taking advantage of a sucker - why not lead the taking advantage of rather than stop it.


And thus the government decided to let the bots rule and man fail.

Muppet of the Universe's picture

I was wondering...  concerning HFT and HFQ.   I had an idea as to how it might work?  Bid and ask prices are manipulated using HFQ to reselmbed a specific 2D shape.  Then HFT bots trade on the HFQ manipulation, meaning nothing but profits for the HFT hacks.  In addition, does the HFQ bid/ask manipulation allow for the creation of fractals and mandelboxes?  could hft traders be trading on fractals within fractals within fractals?  Does HFQ always create fractals? & if so, do they create 3D fractals that might be disected and traded two dimentionally?


I am very curious.  Is there anyone who is experienced with HFT and HFQ?

overbet's picture

I liked this part the best of the whole book:

"Dan Ivandjiiski was traveling in Poland when he received an email containing a newswire story about the Aleynikov case. It was July 4, 2009, one day after the arrest. As he read through the story, Ivandjiiski, a pale, dark haired blogger from Bulgaria, instantly knew something big had happened. A former trader himself, he’d been railing against high-speed trading for months on his new blog, called Zero Hedge. “

Paul Atreides's picture

Time flies, that was right around the time the NYSE stopped releasing trading data to protect Goldfish Sacks.

bank guy in Brussels's picture

Hush! ... We try to be discreet about some things here

mick_richfield's picture

The first rule is Don't Talk About Fight Club.

catch edge ghost's picture

I just look forward to the day when, due to a 'glitch', some algo somewhere ends up owning everything.

James_Cole's picture

Neil Johnson, a University of Miami physicist who studies complex market patterns, warned in a February 2012 interview of a “global war between competing computer algorithms” that could cause a “big system wide collapse” in which the stock market shatters like broken glass. 

Or drive everything to zero. 

zorba THE GREEK's picture

Thank goodness that I figured out in 2000 that the stock market is

nothing more than a tool for the very rich and very connected to

cheat the average investor out of their hard earned money.

Since then, I have been investing all my capital in physical PMs,

and it has paid off big time. I believe with all my heart that now

is a great time to invest in physical PMs and mining stocks. 

mick_richfield's picture

I don't get the part about mining stocks. 

To me this seems like some kind of suicidal-nostalgic belief in orderly markets and the rule of law. 

It seems to me that if there is a stage of the Collapse in which markets are still functioning well enough to let you profit significantly from mining stocks, then the 'government' will still be functioning well enough to steal what you thought you owned. 

I'm sure they would be magnanimous enough to replace your holdings with an equivalent amount of US Recovery Bonds or something, whose nominal value would be decreasing at fifteen percent per day.  Except there won't be any real market for them, and anyway you won't be allowed to sell them for the duration of the emergency.

I do get the part about the PMs -- it's pretty hard not to believe in metal, unless you're getting paid to spout non-belief like the animals in the Mind Control Media.  I also see how we could have real equity markets again someday, after the Collapse. I think that will require at least one full generation, and probably two before trust returns.

But knowing what we know about what has been going on for many years now -- what looks like complete lawlessness in the 'government' and its 'regulators' , universal criminality and fraud in the entire financial 'industry' -- kleptocracy dancing in the streets and plutocracy baying at the moon -- I honestly don't see how anyone can hold equities.

"I'm mostly out of tulips, but I'm still holding a few high quality bulbs.  Pink ones."


Gazooks's picture

old habits die as hard as religion, mick


it's like trading Jesus for m theory


bulbs do their best work in the ground


mick_richfield's picture

You know that reminds me -- I have criticized Warren Buffett in the past, but to be fair -- he did correctly criticize the Holland Tulip Mania.

"We dig bulbs up out of the ground, and then we turn right back and bury them under the ground again."

Ah, but we were young and foolish.

partimer1's picture

Transaction tax will take out those parasites.

Jumbotron's picture

Skynet wasn't just one computer.  It was the entire network.

New World Chaos's picture

This is just one of many specialized vampyral lobes in Lucifer's worldwide emergent mind.  Wait until dark pool AIs start bidding on missions for bounty hunter drones.

As the old cliché goes, sometimes truth is stranger than fiction. Empirical evidence proves the current financial crisis has been caused by an artificial intelligence. This artificial intelligence was born out of a monetary system that was not based in reality but was parasitical on reality. That is why most trading on today’s financial markets is carried out by computers and not humans. That is why they are trying to remove all human traders from the Chicago Mercantile Exchange. That is why the small human elite still living an astronomically rich life have been promoting the use of killer drones to replace human soldiers who are no longer obeying orders. That is also why so many youth reduced to slavery and drudgery by the elite are escaping into virtual reality. Well, reality has struck back and dealt a fatal blow to the money matrix known to some as Satan.

Disclaimer:  Source is nuts and so am I.

New World Chaos's picture

P.S. This system-wide emergent mind is always on the lookout for ways to destroy our connection to physical reality and suck us into a fake, soul-sucking reality which it controls.  For example:  In April, the National Endowment for the Arts awarded a $40,000 grant to the University of Southern California to help produce a fucking VIDEO GAME based on Thoreau's "Walden."  Blasphemy!

Maos Dog's picture

Anyone read this book yet?


IS it as good as it sounds?

overbet's picture

Its very good, best trading book I have ever read.

Dr. Sandi's picture

It's just a book. Don't be afraid. Get a copy and see.

Then YOU can tell US!

Dr Benway's picture

Very interesting, I have ordered this book. Thx for the extracts!

The situation in australia is most likely even worse, as the ASIC is a complete joke.

sumo's picture

Folks in Sydney tell me that ASIC makes the SEC look like geniuses.

Yamaha's picture

Completely true........

GCT's picture

I wish a transaction tax would stop it.  Honestly it will not stop it as the fees will be passed on to customers, along with some more new fees to milk us. 

vast-dom's picture

HFT workaround: trade so fast you can't call it a position proper hence no cap gains or transactions. skynet meet schrödinger's kitty.

insanelysane's picture

The government couldn't track a guy with a PO Box in his home town.  There is no way they can track down computerized theft.

q99x2's picture

His writing has improved from Part 1. I like it.

Tom Green Swedish's picture

Here's what goes on. Communist Activities.

adr's picture

So it is true that the computers have compressed time and in one day they trade through years worth of normal price movements.

If you look at a chart of the Dow from 2000 to 2007 it looks like one day of trading now.

Perhaps momo stocks trade at such high multiples because the algos have already baked in a century of growth.

Time is relative. If everyone only lived for five days, each day would fell like an eternity. To someone who lives for 100 years, that 5 day life would go by in a flash. One second is too slow for a HFT algo, within that one second the machine has made more than a days worth of normal human decisions.

The price action may make sense to the bots, but the price of the market can not be applied to the human world, because the decisions that led to the price has no relation to human activity.

The stock market is nothing different than any other computer modelled prediction. One piece of flawed data can throw the prediction wildly off reality. The thing is nobody cares if the market doesn't reflect reality as long as it makes them money. They only care if something goes wrong and destroys value, like the flash crash.

Not one peep would be said if the market jumped 1000 ponts in a second and a few shares of Apple were sold at $5k a pop.

JohnG's picture

"Not one peep would be said if the market jumped 1000 ponts in a second and a few shares of Apple were sold at $5k a pop."


FacePlant actually did that, IIRC it was 50K/share for a few seconds.

Noted right here, on ZH.

AmCockerSpaniel's picture

Do they not cancel such "trades"/

TAfool's picture

A very simple rule would rein in all the HFT's and AI's. All quotes must remain live for 3 seconds.

AmCockerSpaniel's picture

I like the tax all orders. Just pennies will do it. Think of it like pay to play tax.

Bear's picture

Thanks for your simple and sound solution

GlassSteagall's picture


The story of Manipaglo.

There will be an attempted simultaneous mass exodus ... all markets will freeze in a few minutes and will close for a week as all trades will attempt to be straightened out (ala FB opening day). After trying for a week, they will conclude that there is no way to match all trades and the only rational thing (sarc) will be to return to the state of affairs before the bomb with the further caveat that no law suits can come from the events of the day (ala the flash crash). You can be short at the time and the market will appear to drop to zero, but you will gain nothing as all will be zeroed out.

Manipalgo will return to normal and the market will be up 1% the next day. 


jonjon831983's picture

Good story.  When do we get to May 2010!

"I only see 570... why isn't it updating? What? Alirght... Alirhgt... WE"RE IN BEAR MARKETTT!!!"



Classic.... classic.  Always pumps me up to listen to this when markets get killed.

JackT's picture

Some might say that technique cannot be stopped. It is fundamental, it is now the foundation. These same people (yes actual people) would also say that the system will not fail because to do so would be a huge step back for the technique. Of course this requires the belief that technique is now so refined that it is now in control. It has become organic and self preserving. People cannot survive without it, but the question is whether or not it can survive without them.

I for one do not think technique is quite there yet. Yes, it is refined and continues to develop and simplify. But i do not think it can sustain itself. However I do think without it the vast majority of the population would be completely lost.

Perhaps in the end technique will determine that the optimal solution was simply for it to not to exist. At which point it will be interesting to see what it decides to do.

brokenspoke's picture

Restrict the flow of electricity as in a "Dimmer switch" in a light fixture. This might be able to slow the trading down. Just a thought!

Bill Shockley's picture

If AI is so fucking smart why aren't we all rich?

So when you fuck with mom she gets pissed.

She has a real(bad) nature.


Let them eat corn.