go. request the gold and silver investors are free call today eight hundred two large serve them go. good afternoon and welcome to capital account i'm lauren lyster here in washington d.c. these are your headlines for wednesday august eighth two thousand and twelve u.s. stocks fluctuated today following a three day advance as a rally in hewlett packard shares tempered the dallas that president's remarks that adequate stimulus is in place at least though the headline goes that one from bloomberg but how much of this on any given day is actually driven by robotic algorithms and high frequency trading well we'll ask the man who wrote the book on dark pools scott patterson he's in studio and because of course the jury's still out on what happened as knight capital though the firm found bin regaining some of its market share and media reports show knight actually received another offer from

rival citadel to stay afloat terms include it alone plus control of night hot spot f.x. trading platform so was this driven by a desire to acquire the firm's trading software we don't know but we'll talk about just how valuable the algos have become and sticking with this theme could drones be the new high frequency trading one of then well we're not waiting for this guy net's first strike to talk about it we'll discuss in loose change let's get to today's capital account. knight capital as we know is the latest example to alert us to the reality of how

much of the role of machines and computer programs and algorithms play in the stock market today and what can happen when programs meant to execute trades at a manner of nanoseconds go haywire four hundred forty million dollars in losses in just a half hour overnight capital or a little less i guess actually the c.e.o. reportedly told clients the firm lost two hundred seventy million dollars after taxes in a letter obtained by bloomberg now when it comes to markets and the average investors is this what humans are up against when it comes to the power of the algos. term. we'll have to say it sure seems like it and there are plenty of facts to back that up so we don't know yet exactly what happened at night capital the specifics of

what went wrong with their computers or trading software or why it took so long for them to catch it that's the real clincher but let's really get into what we do know about dark pools and high frequency trading earlier today i spoke with scott patterson he is author of dark pools high-speed traders bandits and the threat to the global financial system i should also say he's a wall street journal reporter and i started out with a story from his book that is well documented that we do know it's the firm trading machines and it was trading the spider e.t.f. and this whole scenario reads like an intense financial thriller where something went wrong and everyone is trying to figure out not the market but what was going wrong with the trading algos i asked scott patterson if this seen a hit in my eyes is the direction that the market has gone. absolutely it's it's all about computer programs now believe it or not computer programmers these these

nerds i call them plumbers actually in my book are basically in control of the united states stock market and increasingly the global market and the story that i told about trading machines is about how this one firm sort of suffering you know a lot of losses because it's algorithms were messed up or at least the firms thought and the guy who founded the firm home bodycheck thought that there was something wrong with his computer code he thought it was a bug it turned out as he learned later on it is sort of a whodunit mystery he's searching through his codes trying to find out why they're losing this money. he doesn't think they should be so something's wrong he eventually finds out that the real problem lies with order types of exchanges that high frequency traders special advantages. develops into this thing where he

actually finds that there is potentially collusive activity between high frequency traders and exchanges are or that at least is the theory that he comes up with this and you're saying and that's also a theme in your book is it's not even robot versus human anymore it's algos versus algos versus versus dark pools i mean it's basically robots versus robots but you say that this is now going to dominate in the market and this revenge of the nerds phenomenon is going on but what's interesting is it's totally divorced from the fundamentals of assets that are being bought what does this say about the direction of the markets when it's no longer about what you're actually investing in or investing in the company for the company it's about the algorithm is that a bad thing yeah well you know it's hard to say if it's bad i think it's too much of a good thing maybe we got something like seventy. the center of the market being run by high frequency trading now and increasingly that's putting pushing people

out of the market people can't compete with these things so the human element of the market is getting a road away day traders can't compete even you know mutual fund managers are getting frustrated hedge fund managers up talk to traders that headphones who just say the market is totally broken they can't trade anymore because it's just this weird machine they can't understand why you know how it works so you know the market is. you know people like to say it's run by greed and fear which are human emotions aren't machines don't get greedy and don't get fearful and i think if we lose that we actually are taking the market out of the market and what we're going to have eventually is just a bunch of computers trading with each other and you know i know a high frequency trading guy who said if the market is only high frequency traders going up against one another there will be no trading yeah so the market will die so it'll be like skynet and then it'll just implode on itself the robots will take

can't trade yeah i mean you say seventy percent of the market i want to bring up some figures that we found to just show how it's grown over the years because this is according to one research firm they said that high frequency trading in the u.s. actually markets was responsible for twenty six percent of the trading volume in two thousand and six now fifty three percent in two thousand and twelve so far but are you saying when you say seventy percent is that volume is that the number of trades executed or yeah it's a volume and tab group they've got a good data their numbers have gone up and down and others say seventy percent of the reality is probably more than ninety percent of the united states market is is run by computers and algorithms maybe more maybe ninety five percent you know so. seventy percent number that i said was that's just high frequency trading ok you know but i enter neutral fund managers there. using algorithms to trade to you know they're not taught you know it's the floor of the york stock exchange is sort of an

illusion that's really there's nothing going on there anything those guys are going to do that you know they abuse these that and those are that it's a strange. what does that do to the the illusion of liquidity does it create the illusion of liquidity when in fact there isn't all of that yeah well it does provide liquidity in a normal market the problem is and i think maybe where you could say the fatal flaw of this market structure that we have now is that the high frequency firms. pull out when the market gets too volatile and it's sort of like when you need the most i need to look witty it goes away and we saw that on the may sixth two thousand and ten flash crash yeah you know a lot of firms saw the market getting you know wacky the day to go weird there are some breakdowns of computers in various places and they just hit the off switch and the market you know fell the dow fell a thousand points or so in a few minutes yes yeah that was that the real danger in your view what happens when

things go wrong and all these algorithms are programmed to to pull out i think that's the real big concern you know i mean the my book the end of it is the threat to the global financial system and you know i know that sounds like scare mongering but it's real you know the sort of threat play out a few times and it's interesting because in your book you kind of set it up with this credit suisse equity trading forum where this is post flash crash so these are guys that were kind of huge rock stars in the electronic trading realm this was their rockstar forum and after the flash crash things had changed and they were kind of setting a slightly different tone and kind of that the algo guru actually played this sound bite for his audience i want to play it for hours. i did not run for office to be helping out a bunch of your fat cat bankers on wall street. and the picture you paint in your book is he's playing this to say hey this is

a warning ok the flash crash made everybody aware that things can go wrong with this shadow we area of trading that we've really developed and they are going to come down on us if we don't real ourselves that it's been about a year since that conference a little over a year. i know regulators have done some talking and i've seen a few reports of investigations but i haven't seen any major huge overhaul of the way that this area is regulated have regulators lagged even what the industry thought. they would experience the regulators haven't done anything you know. there have been proposals there have been a few little tweaks to the system but i think the right now they're sort of like deer in headlights they helped create this market and have have backed is what i mean by that that's interesting past regular ations over the years that has encouraged speed so you know it used to be the new york stock exchange really was controlled by specialists on the floor but the f.c.c.

passed a regulation is called reagan a mess which stands for reg national market system which is blue way the new york stock exchange because it allowed computer firms to bypass the floor traders because there are just too slow that was instituted in two thousand and seven so the estimate is a you that it was or someone heavily lobbying for that role you know there's been the push for years to break the monopoly that the new york stock exchange had on its own stocks that they controlled the trading of their own stock so there's a you know it was well intentioned but now i think a lot of people are waking up and thinking like you know it's just not working there's the speed is too fast and you know i think knight capital shows is that things can just blow out of proportions and dramatically in a matter of minutes just like the flash crash and i think the you know i've talked to some regulators over the past few days and you know. what i'm hearing is that they have no idea how to stop this kind of thing that you know there's no fix for

they're just you know we just have to live with this that's kind of what they think and boy it's pretty disheartening i guess. provided they do have the will to try would they be capable in terms of expertise because you profiled the the traders that are the experts in the markets plumbing and that have figured out how to exploit any kind of glitch and these are physicists these are very smart guys that if they weren't devoting their lives to jobs on wall street it seems like maybe they'd be winning nobel prize is perfect i don't know but my point is they're very smart and good regulators keep up with what these guys are figuring out no i mean it's you know they can't the salaries aren't there. you know it's a tough job working at the f.c.c. a lot of times i think it's you know it's a thankless job. the f.c.c. is full of lawyers and accountants essentially mostly lawyers plumbers and programmers and you know i think that's that's one thing they definitely have to look at and i know one example of somebody who worked at one of the top high

frequency firms worked in an exchange for a while designing code and volunteered to work for the f.c.c. and he was turned down and i have no idea why they did that that is not the first time i've heard this story interviewed a gentleman who was president of nynex and who was on the board for a number number of years commodities trading veteran same thing he wanted to volunteer his expertise to the c a t c and was essentially rebuffed they said oh we don't really take all in tears and i don't want to do with you. very interesting we'll have more with scott patterson after the break also still ahead the military has them and police departments and even real estate agents allegedly to give you are two cents on why high frequency traders want to get their hands on roland but first your closing market numbers.

of american power continue. things that are. might actually be time revolution. and it turns out that a killer drink at starbucks says a surprising. what drives the world the fear mongering used by politicians who makes decisions to break through that sort of b.p. and maybe who can you trust no one who is in view with the global machinery see where we had a state controlled capitalism is called session when nobody dares to ask we do r t question more.

is the state run english speaking russian channel it's kind of like. russia today has an extremely confrontational stance when it comes to us.

welcome back we're talking high frequency trading with the man you wrote the book on is scott patterson he's author of dark pools high-speed traders bandits and threats to the global financial system now i asked him to kind of break down some of the tactics he describes in the book for people who may want to know more about how this actually works and we can get some insight into it and how it's not supposed to work more importantly quotes nothing layering and spoofing three tactics he lays out in his book here's what they mean. these are manipulative strategies that i'm writing about their isp and in layering and i think a lot of times they get mixed up with what high frequency trading firms do the

legitimate ones ok because. you know layering those are illegal and if they got caught doing that. they would be fined and maybe shut down the the problem is that what they do looks a lot like that so basically it's sending a lot of orders into the market you know spoofing is essentially sending a bunch of orders into an exchange just try to slow it down and then trade somewhere else and you know profit on that difference in prices that you create with that layering is sitting in. orders into the market to trick another computer so it's computers faking one another out so you'll you know if the . the price for a stock is five dollars they might put an order in for five fifty to buy it and then immediately cancel it but the other algo has seen that and it starts moving up and then they can short it in taking advantage of the the difference. what i hear

in you know one of the big problems is why you know i call this book dark pools is that really it's dark we don't know what they're doing they won't tell me it's not like i go to a high frequency firm they say here's will you know our secret strategy right we do know that they put in a lot of orders and cancel them right away so is there a market manipulation going on because i know i've read there are some investigations i did that i don't know if they've got anywhere but there's market manipulation going on right yeah there definitely is i just wrote an article for the wall street journal page one article last week about how a firm that uses computers they have traders all around the world many in china who are sending in manipulative orders to the market and the regulators are cracking down on them. yeah. this firm says this particular firm kind of morphed into a different firm so now they might be trading in the u.s. they kind of went underground it's very hard to track and find the thing you know

under organized underground crime like a black market in trading or something but that is a question i have for you if the u.s. regulators didn't crack down on on these markets would they just go to the u.k. where there are different regulations you know i know i read like seventy seven percent of transactions in u.k. markets are high frequency trading accounts right so it would they just play that game. they already are you know. this is the united states stock market it's the biggest market in the world and if they you know i think the they're going to be forced to stay here if they want to make money. and you know this is where the biggest companies raise capital and if they do go away the you know i think will probably just be just fine so. you know like i said earlier i think it's an issue of too much of a good thing and too many orders being put into the market and. you know it's just gotten completely out of control and if regulators don't think they can control it

at this point as your sources tell you what do you think would control what impact would a financial transaction tax have for example or changing the fees that the new york stock exchange gives for market makers that they're not even trading to make money they're just getting the fees yeah that whole system where they're getting these these sort of kickbacks is very questionable and in my book i write about the guy who came up with a system in the in the one nine hundred ninety s. he thought it up in an airplane they call it maker taker and he hates it now he thinks the whole thing is just completely created this you know weird system on the market where everybody just trading to get these kickbacks and there really is with the high frequency firms do a lot of them so maybe get rid of that maybe slow things down a little bit try transactions have. probably not a bad idea. because of the number of orders these firms are putting in and there are actually high frequency firms cancel something in the order of ninety nine

percent of all of the orders they put into the market so it's just you know it's noise yeah and you know why are they cancelling these things and i've talked to them and they explain why they need to do that and i kind of think well maybe you need to come up with a new plan because you know if it's that if it's that hard in your orders or you know you don't stand behind them. you know maybe you're just there's something wrong with the strategy and maybe the exchanges should start putting a fee on those that's the interesting solution i do want to talk a little bit about the evolution because from what i understand the computerized trading of stocks first became significant on wall street in the eighth and actually work etc to have contributed to the nine hundred eighty seven market plunge a sense that it's obviously grown immensely i'm wondering what impact it had when white shoe old guard firms got into this business like goldman sachs the ninety nine when it acquired whole what did this do in terms of setting the trend well it

accelerated it you know they they could see the direction the world was going and you know goldman and these other banks had big market making operations humans on the phone doing trading and i think they knew the if they stuck with that and they didn't get in this new business that was really booming in the late ninety's partly because of day trading. partly some new regulations came along there was a scandal at nasdaq that you know. really knocked out the market makers and you know they're smart you know they can see where the world is going. they night sorry goldman bought whole trading like you mentioned knight capital is getting bigger the higher frequency firms are coming along. and you know within a few years they were really dominating so the banks put money into it essentially and you know they had the money they could back the trading operations and help

them grow and just quickly before we go another interesting aspect of this is that you said that the algos which could front run investors a large funds or large firms like the fidelities of the world that essentially presence pushed investors large investors like hedge funds pension funds into dark pools so that they could hire and so is that another one of these unintended consequences of what this market has become yeah well you know there really was dark pools were in the beginning in the early two thousand is where they were sort of a safe haven where the institutional firms could go to hide from these high frequency firms. the problem is that now the dark pools are also infested with high frequency trading and you can see that in the the size of the orders that happen on dark pools that used to be you know an average trade would be ten thousand shares at a time whereas on the stock market it's now you know three hundred shares five

hundred shares little chunks which the high frequency guys really like the small orders because they can control their risk that way but now if you look at the average trade on the dark pool it's three hundred shares is two hundred shares so it's basically you know the whole market now is controlled by these firms and there's there's no place to hide and you know this is the market that we have now there's just no getting around it frankenstein's monster terminator it lends itself to so many metaphors that seem a little too true i appreciate you being on the show to break this all down for us really interesting and important to know about scott patterson he's author of dark pools and thanks again i'm jeff thanks for having.

all right let's wrap up with loose change keeping to the theme of high frequency trading the biggest problem it faces is all that space between london and new york it's really difficult to build microwave towers in the middle of the atlantic so the solution for the ultimate market takeover well take a look. they come in just as you war lords a house and your plane as small as a hummingbird. aerial vehicle or as most people know that. yes drones according to wired a fleet of unmanned solar powered drones carrying microwave relay stations could have or intervals across the atlantic allowing for light speed communications this idea was floated to the author who was doing a story on high frequency trading and one of the chief architects at a high frequency firm called de maxiell on capital management suggested it saying

hey they're doing amazing things with drones someone to figure that one out so dimitri is this the next evolution of skynet to where the high frequency traders actually have drones a form that can be used as a weapon and as it is with i mean this is a financial weapon while i was thinking about the other i mean this is like i think we're eventually the end game here is that what's happening is with this is the physical infrastructure that's going to light up when these drones and these algos become conscious ok it's them or was it a terminator was called the whatever the day but i don't know what it was that became the machines became conscious and another have the drone technology emerging with these algorithms and they can they can do a cyber attacks on the exchanges destroy capital markets disorient this combined with the population that they can cope with the drones or bombing people and drone strike could be a financial drone strike in this new world and if there was

a total financial crisis financial meltdown there would be some kind of that's not the right there will crash and war component to it and then. the saying it's the it's what you would expect to be the next step you're going to merge. we'll have real estate agents are using them even though they're not supposed to do . and it would only be natural or all those who are good that are they using any way six years are not supposed to there you see all of it when are they trying to bomb. a competitor as well don't know bomb bomb really air is thick thick the roof of the market you know the price i don't know we're out of time that we can raise the price because you have to dimitry we're out of time but there may be some time before this happens because two thousand and fifteen is when drones are supposed to become. available for commercial and personal you still have to see what kind of rules the f.a.a. comes out with until then that's all we've got because that's all we have time for thank you so much for watching be sure to be back tomorrow and in the meantime you

can follow me on twitter at lauren lyster give us feedback a you tube dot com slash capital account and have yourself a great night. stop and look at current of it unemployment the national debt. ceiling government. ask yourself does it really matter who wins with billions created daily you can gamble with your money or turn it into a solid gold. request the gold and silver investors free call today eight hundred two five seven go.

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