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

Posted by Jeff Carter
on July 9th, 2012

A guest post by Ryan Holiday. Book Review on Dark Pools.

Dark Pools: High-Speed Traders, A.I. Bandits, and the Threat to the Global Financial System is one of those books that takes something you thought was boring and banal and make it into something scary and real. As they say, the best way to get away with something evil or dangerous is to make it boring. WSJ reporter Scott Patterson used his storytelling skills to make it harder for traders to get away with the most dangerous tricks of the modern market: high frequency trading, artificial intelligence bots, and self-generating trading algos.

The book spotlights a system controlled and manipulated by characters trying to make their own private markets where effectively “can’t lose.” He describes the techniques developed by the market pioneers, the devastating effects for average consumers, and how the influence of the machines will only expand in coming years.

One such character is Josh Levine, the eccentric high school dropout who created Island, an electronic pool which would eventually handle over 100 million trades per day. Levine, armed with his extensive trading algorithms, would not only single-handedly beat the market, but provide select others the tools to do the same, time and time again. Peter Stern, founder of Datek Online and the recipient of many of Levine’s creations, is quoted in the book that with Levine’s products “you could be a high-school dropout from the wrong side of the tracks and be a millionaire in a month”.

The success of Levine and others began a technology arms race. Good algorithms would thrive and create new billionaires overnight. Bad ones would die, starved of the cash to keep them going. Soon algorithms were creating algorithms, and the computers no longer needed human input. They could learn on their own. The result was an almost fully automated market with computers watching other computers and reacting on the others actions. Computers were also making decisions completely independent of any living being. One small glitch and the result could be magnified due to the interconnectedness. The book highlights a prime example- The Flash Crash. On May 6, 2010 the algorithms, confused by an unusual order, plunged the the Dow Jones Industrial Average down over 1000 points (9%) in seconds, the biggest intra day drop in history.

Dark Pools is an exciting overview of history of financial markets and the rise of the computers which now control it. It introduces the firms, personalities, and events which created the monster. Patterson shows all the signs of a great story teller, relaying abstract concepts in a clear and enthralling narrative. A comparison to Michael Lewis’ The Big Short or Liars Poker would be easiest, due to the subject, while Patterson may have provided more detail. The book is entertaining and scary. The more people who read it, the better.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.