Dark Pools: High-Speed Traders, A.I. Bandits, and the Threat to the Global Financial System
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.
“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.