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

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 early December 2009, Haim Bodek finally solved the riddle of the stock-trading problem that was killing Trading Machines, the high-frequency firm he’d help launch in 2007. The former Goldman Sachs and UBS trader was attending a party in New York City sponsored by a computer-driven trading venue. He’d been complaining for months to the venue about all the bad trades—the runaway prices, the fees—that were bleeding his firm dry. But he’d gotten little help.

At the bar, he cornered a representative of the firm and pushed for answers. The rep asked Bodek what order types he’d been using to buy and sell stocks. Bodek told him Trading Machines used limit orders.

The rep smirked and took a sip of his drink. “You can’t use those,” he told Bodek.

“Why not?”

“You have to use other orders. Those limit orders are going to get run over.”

“But that’s what everyone uses,” Bodek said, incredulous. “That’s what Schwab uses.”

“I know. You shouldn’t.”

As the rep started to explain undocumented features about how limit orders were treated inside the venue’s matching engine, Bodek started to scribble an order on a napkin, detailing how it worked. “You’re fucked in that case?” he said, shoving the napkin at the guy.


He scribbled another. “You’re fucked in that case?” “Yeah.”

“Are you telling me you’re fucked in every case?” “Yeah.”

“Why are you telling me this?”

“We want you to turn us back on again,” the rep replied. “You see, you don’t have a bug.”

Bodek’s jaw dropped. He’d suspected something was going on in- side the market that was killing his trades, that it wasn’t a bug, but it had been only a vague suspicion with little proof.

“I’ll show you how it works.”

The rep told Bodek about the kind of orders he should use— orders that wouldn’t get abused like the plain vanilla limit orders; orders that seemed to Bodek specifically designed to abuse the limit orders by exploiting complex loopholes in the market’s plumbing. The orders Bodek had been using were child’s play, simple declarative sentences sent to exchanges such as “Buy up to $20.” These new order types were compound sentences, with multiple clauses, virtually Faulknerian in their rambling complexity.

The end result, however, was simple: Everyday investors and even sophisticated firms like Trading Machines were buying stocks for a slightly higher price than they should, and selling for a slightly lower price and paying billions in “take” fees along the way.

The special order types that gave Bodek the most trouble—the kind the trading-venue rep told him about—allowed high-frequency traders to post orders that remained hidden at a specific price point at the front of the trading queue when the market was moving, while at the same time pushing other traders back. Even as the market ticked up and down, the order wouldn’t move. It was locked and hidden. It was dark. This got around the problem of reshuffling and rerouting. The sitting-duck limit orders, meanwhile, lost their priority in the queue when the market shifted, even as the special orders maintained their priority.

Why would the high-speed firms wish to do this? Maker-taker fees that generate billions in revenue for the speed Bots every year. By staying at the front of the queue and hidden as the market shifted, the firm could place orders that, time and again, were paid the fee. Other traders had no way of knowing that the orders were there. Over and over again, their orders stepped on the hidden trades, which acted effectively as an invisible trap that made other firms pay the “take” fee.

It was fiendishly complex. The order types were pinned to a specific price, such as $20.05, and were hidden from the rest of the market until the stock hit that price. As the orders shifted around in the queue, the trap was set and the orders pounced. In ways, the venue had created a dark pool inside the lit pool.

“You’re totally screwed unless you do that,” the rep at the bar said. Bodek was astonished—and outraged. He’d been complaining for months about the bad executions he’d been getting, and had been told nothing about the hidden properties of the order types until he’d punished the it by reducing the flow he send to it. He was certain they’d known the answer all along. But they couldn’t tell everyone—because if everyone started using the abusive order types, no one would use limit orders, the food the new order types fed on.

Bodek felt sick to his stomach. “How can you do that?” he said.

The rep laughed. “If we changed things, the high-frequency traders wouldn’t send us their orders,” he said.

* * *

More tomorrow

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john39's picture

does anyone really need the details at this point?  the bankers used the central banking system to take over governments...  now they run the world (most of it).  The laws are rigged, the markets are rigged, along with most everything else.  the truth is, most of humanity are slaves, in invisible cages with chains most can't see.

BattlegroundEurope2011's picture

Time to start lynching these SOBs

Thomas's picture

Gimme a bat and ten minutes and it would be a sequel, "Silence of the Bankers".


I'm thinking Thomas and Robot Trader's avatars should duke it out . I got 5 Eagles on Thomas. Anybody in on the action ?

CaptainObvious's picture

If there's gonna be a girl fight between sexy avatars, look no further than Waffen's avatar.  I'd pay money to watch that girl fight.

RobotTrader's picture

Those shenanigans only affect the Monster Energy-swilling day traders and mo-mo monkeys.  If you look at a 3 year chart of the Dow, anybody who bought quality stocks near the lows has done well, and the quote stuffing, dark pools, etc. have had no impact on the investment performance.

Anybody who bought KO, WMT, DIS, JNJ, etc. could care less about all these minute wiggle and games played on a day to day basis.

Every quarter the dividend checks roll in.

Every year, the stock's average trading price is higher and higher.

If you are a holder of gold stocks, well that's another story.  Naked short selling, last minute take downs, and horrid year over year performance the last 5 years has definitely taken a toll.

LawsofPhysics's picture

Wow, that was a really quick "pay no attention to this" reply. On a Saturday night no less. Things that make you go Hhhmmmm.

El Oregonian's picture

Robotrader is a known Govt. troll... Just junk him and move on...

Marginal Call's picture

He's sort of right.  Half a tick doesn't matter to a swing trader or a long term investor.  And I rarely use limit orders for entry either.  When I make the decision to place an order I usually go straight for the market order button.  I've missed way too many trades trying to go a half tick deeper.


If the market is choppy and rotating in a point and a half range and I want out, I'll put a limit order in the dom to see if I can get out with a small profit.  But then again,  I close at market often too because I've lost profit or booked a bigger loss trying to squeeze out another .25 cents too many times. 

Dr Benway's picture

This is exactly the sort of thinking that allows the parasites to suck your blood a little at a time.



If you steal a tiny bit out of a lot of transactions, it adds up.

Marginal Call's picture

My thinking is I'm willingly playing a game that I know is tilted, and if I know I might have trouble getting filled because of it-I do what I have to do to get filled.  But while one part is tilted against me, not all parts are.


Rigged markets become predictable markets. 

LawsofPhysics's picture

correct.  Well, at least until all the paper is worthless.  history shows that the latter is always "unexpected".

Marginal Call's picture

I'm not fully prepared for that moment.  That's why I still play.  Where else can I pull large sums of paper to convert into land, tools, silver and seed?   


Only the dullest of idiots is ever all in on anything.

calltoaccount's picture

Bad to the bone.  This is just another one of their numerous crooked games.

"Wall Street has long considered Main Street “the dumb money.” theirs, almost by right, and certainly by tradition, for the taking.  Not surprisingly, they created a culture of corruption that’s proven itself bad to the bone.  What other industry has literally dozens of words and phrases characterizing unethical, illicit conduct?  (Backdating, Channel stuffing, Cherry picking, Churning, Cookie jar reserves, Cooking the books, Dummy accounts, Earnings management, Flipping, Fomenting, Free-riding, Front running, Insider trading, Late trading, Lulling, Market timing, Marking the close, Matching orders, Naked options, Naked short selling, Off balance sheet, Painting the tape, Ponzi scheme, Puffing, Pump and dump, Pyramid scheme, Round-tripping, Scalping, Selling away, Short and distort, Spinning, Spring loading, Tipping, Touting, Trading ahead, etc., etc., etc.)  God’s work, indeed.

Bringin It's picture

... numerous crooked games.

is the key take away.

holdbuysell's picture

This is an excellent point. As a multi-year hold investor, you may not care about the inefficiency (scam). However, if many buy multi-year and they do this over the long term for 401k, etc., the amount siphoned could add up to huge money.

Contrary to the concept of "picking up nickels in front of a steamroller", this is analogous to picking up nickels from a fountain in a hotel--very easy to do and only the scum of the earth would consider it.

The markets are screwing everyone (as a society). Save/invest the hard-earned fruits of your productive efforts somewhere else. Ideally your community. There's lots of just need to look.

If you don't know who the sucker's you. True. True.

RockyRacoon's picture

Your analogy is much deeper than you may imagine.  Those coins in the hotel fountain were all placed with a wish, and a hope for something better, or a good thought for another.   Regular folk are being robbed of their futures and their hope for a better life -- a nickel at a time.  

Stackers's picture

And if you look at a 5 year chart of the DOW anyone who bought qualitiy stocks has been taken for a roller coaster ride and are lucky to be back at break even at best.

DavidC's picture

Spot on.


jeff montanye's picture

twelve years, but who's counting?

PivotalTrades's picture

Better yet deduct the infation and come up with about 20 years of nowhere,,I mean the real inflation not the that joke the Gov. prints.

algol_dog's picture

All they'd have to do is slap just enough of a fee per trade or share, to offset any profit that this enables, and this crap would end instantly. How hard is that?

Nid's picture

Or better, go back to 1/8s ..... Never should have gone to .01s in the first place.

JohnG's picture

Or just restore the uptick rule.

RockyRacoon's picture

None of those changes were made without malicious intent.

MeelionDollerBogus's picture

Do you understand nothing? "they" slap a BONUS on every trade even if it's a small loss of a trade just for making more than x trades PER SECOND

Hulk's picture

Thank you Bob Brinker...

Bobbyrib's picture

I love how bulls always pick the time span that makes their argument correct. If you bought stocks five years ago, you're not in such great shape. That being said I understand Robo's function on ZH..

MeelionDollerBogus's picture

If you look at a 3 year chart of the DOW you're either an idiot or analysing the effects of QE1 and QE2 to predict QE3's amount & timing. Stock valuations from 2009 March on have no meaning whatsoever except to describe criminal activity on a minute-by-minute basis.

If you are a holder of gold bullion you've out-done the market by miles for having a larger cash-pile AND no counter-party risk. Double-kudos for those using Options on GLD all the way up and down.


CreativeDestructor's picture

and they send free porn subscription to SEC staff...

misterbear's picture

Any sense when Greece will be pushed out.  Hurray the world is saved until we hear Greece needs more money.  

If I was a citizen over there I would be taking ECB loans left and right - hording Euros - and waiting till the day Greece defaultsw so I could bring back the Euros into the country - convert them to Drachmas - and quickly pay off the loans and have tons of cash left over.  Thanks Germany.

Rogier's picture

Kinda off topic, wouldn't you say?

RockyRacoon's picture

Some folks get a brain fart and like to waft it over to threads that are irrelevant.  He's surely the smartest kid on the short bus.

LawsofPhysics's picture

Let me summarize in a single word - " bidless"

Nid's picture

Typical fucking bullshit.

How about this one? Fucking NYSE saving an HFT from it's own piece of shit, manipulating algo...and boasting about it.

Cognitive Dissonance's picture

New world order trading axiom.

There's a fool sucker born trading every minute nanosecond.

I am Jobe's picture

So how is the 401K investment coming along? Just ask a sheeple and the match. Dreaming and more hope and change.

El Oregonian's picture

You mean "Hope and Plunge" don't you?

LawsofPhysics's picture

Half a million in paper that will soon be devalued to nothing I'd be pissed too.  He should convert it all to PM's, beans, guns, and bullets, just to see how fast the FBI shows up.  See the latest list released with NDAA for reference.

Seize Mars's picture


Apparently all those sad GM pensioners had no problem with looting & stealing from the bondholders.

Fuck them. The guy in the story with a half million dollar buyout and retiring at 60? Fuck him. He should have to compensate bondholders. Oh the humanity! Retiring when I'm 60! With a half-buck! Boo Hoo!

Guess what, ole Seize Mars ain't retiring at all. Ever. Am I supposed to be sympathetic to these lazy, spoiled union bullshit artists?

LawsofPhysics's picture

While I agree with your general sentiment (I was a GM bondholder that got fucked too), this is about the rule of laws and contracts, break a deal etc...


Wouldn't it be nice if the fucking owners and management actually had to repay the creditors with their own wealth the next time their "leadership" tanked a fucking company.  Easy to shoot the messenger or the little guy, does nothing to address the real issues.

No more fucking bailouts, period.

MachoMan's picture

Since the inception of contracts, it has always been a right to break them...  especially when it is in your financial interest...  often times, the law attempts to take that advantage from you, but sometimes it fails.

The biggest issue is with the limited liability protection afforded by every de minimis entity...  it is virtually impossible to pierce the corporate veil...  and the barriers to entry for creating even a single person limited liability entity are nil, at best.  The law has ended up condoning entities as the alter ego of their owner(s).

I've said it before, but we need to return to sole proprietorships, partnerships, and limited partnerships...  anything past that is an abomination.  The risk of/incentive for inappropriate behavior is simple too great for society to bear.  There isn't any public policy justification when the totality of the circumstances are contemplated.

If you want limited liability, then be a limited partner and stay the fuck out of management.  Alternatively, buy insurance...  alternatively, be a good draftsman in all of your business endeavors.

Everything becomes so complicated, it takes a monumental effort to understand how it all fits together... 

Seize Mars's picture

MachoMan, despite really digging "the" Macho Man, I must say I found your post to be, well, embarrassing. You have all kinds of self contradictions.

"Since the inception of contracts, it has always been a right to break them..." What? A "right" to...oh hell, forget it.

Dude there is nothing wrong with the corporate entity. Next you will be saying that guns kill. (Do pencils misspell words?) We need enforceability of contracts and money that is impossible to counterfeit. That's just about it. If all relationships are consentual, if all transactions are free from coercion, then it doesn't matter what the corporate capital structure is.


MachoMan's picture

Yes...  you have a right to break contracts...  you also may have an obligation to the other party(ies) for breaking the contract...  but you have a right to break contracts.  Think of the "marriage contract"...  the law doesn't want people to stay together that don't want to be together...  you have a right to default.

There is nothing wrong with the corporate entity in an academic vacuum...  however, once introduced to the real world...  and real human ingenuity (you know, when money and power are actually on the line)...  it takes a bit of a different character.  In the present case, it amounts to principal actors of the fraud being free from personal liability for things that literally negatively affect every human...

I'll conclude with the smart money is on a vastly less complicated world... which necessarily entails a pruning back of limited liability (it's a function purely of lobbying, not of public policy).