When you buy or sell a futures contract, your order is sent to a single exchange. For each futures contract, whether it be crude oil, Emini SP500, or wheat futures–the order must be sent to a single location–no exceptions.
Everyone that wishes to either buy or sell must participate in a highly regulated, insured and uniform auction process. With futures markets, there are consumer protections abound.
With futures contracts, there is complete transparency. Each order that arrives has an electronic marker. This marker allows the exchange to track who is doing what, when, and how much.
Nearly all futures contracts within the United States pass through either the CME Group or ICE (Intercontinental Exchange). Nearly all European futures contracts pass through Eurex.
The CME Group, ICE, and Eurex are nearly ubiquitous. The regulations for each exchange are virtually identical, highly transparent, and a robust regulatory infrastructure watches each and every tick like a first-time mother watches her new baby.
It is in the exchanges best interest to guarantee and ensure that a free and fair auction takes place. And with all market participants granted equal opportunity to buy or sell, without implicit advantage.
Like all markets, ‘bad apples’ and cheaters will always show up. Looking for an advantage, they find soft spots and gray areas in the published rules of the auction and seek to profit.
With futures markets, the primary form of cheating is spoofing and quote stuffing.
Quite simply, this means that the cheaters and bad apples will place large phony orders onto the exchange in hopes of fooling other market participants that prices will be heading higher or lower. Before these orders can be filled, the cheaters will quickly cancel the manipulated orders. It works, and it is profitable for the cheater. But it is also highly illegal and criminal.
In short, the cheater manipulates order flow and creates a false impression that ‘big players with big volume’ are desperate to push prices higher or lower. Thus tempting retail traders into hurriedly executing orders based upon fraudulently inserted information. “Fake news” for traders.
With futures, the cheaters often profit easily in the short term, but in the long term, they are eventually caught.
The penalties are severe. The futures exchanges are robust and work aggressively with Federal law enforcement to prosecute offenders. The end result for the cheater is usually a prison sentence. The following are just a few recent examples for ONLY January 2018:
- Andre “Fuckface” Flotron
- James Vorley and Cedric (the Dick) Chanu
- Jiongsheng (Hopsing) Zhao
- Krishna Mohan
- Jitesh Thakkar
All have been recently charged with fraud by the CFTC and the odds are high that each of these characters will soon be serving long prison sentences in a Federal prison.
The CFTC (Commodities Futures Trading Commission) also aggressively prosecutes the corporate enablers that allow these individuals to rip off fellow market participants.
A few recent examples include:
- Deutsche Bank fined $30 million for spoofing precious metals futures contracts.
- UBS fined $15 million for allowing traders to ‘spoof’.
- HSBC fined $1.6 million for allowing traders to ‘spoof’.
It seems that 7 or 8 times each year, the CFTC and the FBI will announce a new round of enforcement actions and arrests for spoofing and attempted market manipulation.
As long as there is a profit motive, people will always find ways to cheat each other. This will never change.
As depressing as it all sounds, you should take a great deal of comfort in knowing that the CFTC aggressively and ruthlessly hunts down ‘evil doers’. Once they are caught, they are then handed over to the FBI for the final butt rape. Not very fun. I should know.
Lets now take a look at the evil cousin of the futures markets…the US stock markets.
United States Stock Markets and Reg NMS
The US futures markets are tightly interwoven, with a robust and centralized enforcement and regulatory structure. The US stock markets are the exact opposite.
You are probably not even aware that there are currently 44 private stock exchanges (Dark Pools) and 14 public exchanges. Generally speaking, there is a loose-knit regulatory structure that is in charge of keeping this herd of cats from ripping off investors from market manipulators, spoofers, and pump and dump scam artists.
The unspoken ‘secret’ is that the US stock market is pretty much a wild west type situation where all manner of shady activity is slipping through an antiquated fish net built to capture only the largest and most audacious scoundrels.
In fact, there is so much shady shit happening in today’s modern stock market that I could spend an entire lifetime writing about it, and I couldn’t make even a minor dent on the list of topics.
So, I am going to write about a few shady tidbits that affect a good majority of my readers. Specifically, those that trade stocks through the following brokerages:
- Scott Trade
- Charles Schwab
- Fidelity Investments
- TD Ameritrade
- Interactive Brokers
Before I jump into these brokerages, you need to know about Regulation NMS. What is it? Regulation National Market System was instituted in 2005 and it ‘guarantees’ that whatever stock that you buy or sell, the brokerage must execute the order as the ‘best’ available price, at the moment you enter the order.
Remember, there are 44 private stock exchanges (Dark Pools) and 14 public exchanges. So in effect, the brokerage has to instantaneously figure out which venue is going to give you the ‘best’ price.
The problem is that the brokerage has up to 1 second to figure out whom actually has the ‘best’ price. One second might not seem like a very long time. However, with today’s modern computers, a 1-second price lag is enough time for an eternity of shenanigans to play out. And this is exactly what is currently happening.
Example: you want to execute an order to purchase 100 shares of Apple. The brokerage scans the market and discovers that ‘Dark Pool A’ is currently the ‘best’ price. The order is sent. However, once the order arrives to be filled, the available price is no longer available. It must be now be sent to ‘Dark Pool B’ for execution. Which it is. At a slightly worse price.
Now here is where the fraud comes into play…Dark Pool A and Dark Pool B are colluding information to fool the brokerage into attempting to execute the order at Dark Pool A, which it cannot. The game is to flip the order and force the buyer to execute at a slightly higher price on Dark Pool B.
Sure sounds like front running? Yep, because that is exactly what it is. And its completely legal.
Whoever came up with such an ingenious idea? According to Michael Lewis, the author of Flash Boys, the originator of ‘order flipping’ is none other than Bernie Madoff. Yes, that Bernie Madoff.
Some of you reading this are probably wondering how any of this could actually be real? Its real. And it happening right now. Two very good books on how the scheme is played out can found here:
How profitable is ‘legal’ front running?
Make no mistake, this is legalized front-running. With the Futures markets, this sort of activity would send you to prison. But with the United States stock markets, this sort of activity is actually encouraged and monetized.
How profitable is this sort of activity? The truth is that nobody really knows, but current annual estimates are in the 3-5 billion dollar range. Once again, many of you reading this are probably in a state of disbelief that the figures could actually be this high. But consider Virtu Trading, which from 2009 through 2014, did not experience a single losing day. Or TradeBot, another HFT company, and legal front-runner, over a 4 year period did not have a single losing day.
‘Legal’ front-running is just legalized theft
So how is the scheme executed? All you need to do is search the name of your broker with the search term: Rule 606.
Example: search for the term Scottrade Rule 606. Google will deliver the following link: https://www.scottrade.com/documents/alt/SSICSECRule606Report.pdf
The document will look confusing, and filled with legalese (just they want it too). But the tables included in the document reveal that nearly all of the Scottrade customer orders were executed at either Citadel Securities, G1 Execution Services, or VIRTU Financial. All of these companies are front running customer orders at Scottrade. Why would Scottrade allow this sort of systematic thievery take place? Because the HFT’s (High-Frequency Trading Firms) are paying Scottrade approximately $.000125 per share for the pleasure of stealing your money.
When you think about it…its just crazy.
Run the same search for TD Ameritrade you discover that most orders are sent to Citadel HFT. Which of course, is majority owned by E-Trade.
Read the recommended books: Flash Boys and Broken Markets and you will discover other crazy shit. Like how TD Ameritrade actually sells keystrokes to the highest bidder. What does that mean? As nutty as this sounds, TD Ameritrade tracks data from retail investors in real time. Imagine your dear old mother keying in an order to buy 100 shares of Apple.
As her feeble fingers gingerly navigate the keyboard, the actions (in real time) are being sold to an HFT firm. Regardless of whether mom is actually placing an order, they are tracking her keystrokes. Pretty crazy huh? When I read it, I was pretty much floored.
Corporate greed knows no boundaries. To follow your keystrokes in anticipation of your order is just ruthless. With stocks, its completely legal. With futures, they would build you a new prison.
So what can you do?
Obviously, nobody wants their keystrokes recorded. Or their orders systematically front run and filled at a slightly worse price. So, what can you do to reduce being taken advantage of? There are a few things you can do.
If you are a scalping day trader, consider avoiding the big name US stock brokerages like TD Ameritrade, ThinkOrSwim, eTrade, Charles Schwab, etc. Consider scalping with only futures on the CME, ICE, or Eurex. The CFTC won’t allow private companies or individuals to front run your orders. The only legal advantage that they can actually obtain is through colocation. In other words, by having a computer housed at a data center close to the exchange.
If you are going to day trade stocks, then make every available effort to avoid market orders. A market order is just begging to be ripped off.
Be cautious and cognizant of where your broker is actually sending your orders to be filled. For example, a very popular stock brokerage and trading App named Robinhood promises ‘Free Stock Trades.’ Which sure sounds great. Until you read the Rule 606 disclosure and it reveals that most of the orders are being sent to Citadel HFT or Two Sigma HFT which is paying .0024 and .0016, respectively for the pleasure of front-running your order.
A further search reveals that Citadel was recently fined $22.6 million for ripping off small retail investors. According to Finra, Two Sigma HFT has been fined countless times for Reg NMS rule violations (not filling customer orders at the best price, front-running).
The problem is that retail traders just assume that their brokerage is going, to be honest, and do what is best for the client. Nothing could be farther from the truth!
What the heck is the IEX? The IEX is a brand new stock exchange named The Investors Exchange. And quite simply, the exchange was designed from the ground up with only one purpose…to even the playing field between the retail trader and the HFT’s.
The IEX stock exchange was recently launched in September 2016, and its growing quickly. However, much of the growth has been fueled by larger institutional investors that were tired of HFT’s front-running their orders.
The tipping point will not occur until the small, retail investor demands that the front-running stop. They need to demand that their brokerage stop selling their orders to the highest bidder, and demand that their orders be filled at the IEX.
Obviously, stock brokers do not want retail investors to route their orders over the IEX. The IEX is a true auction and does not pay the exorbitant front-running commissions that brokers now enjoy.
Some brokers have broken ranks are now offering a ‘front-running free environment.’ For instance, TradeStation now offers stock trades on IEX. Same goes for Interactive Brokers and Lightspeed Trading. But you need to request this change and route your orders manually.
Hopefully, at some point, the dam breaks and firms like eTrade, Schwab, and TD Ameritrade finally make the jump. But it wont happen until retail investors demand change.
Wrapping Things Up
A lot of my readers are small retail customers. Just the type of people that need to read this. And demand change.
And I won’t lie. IEX did reach out to me and asked that I write an article. The biggest problem has been to explain to the retail audience, in plain English that they are being ripped off. And to explain it, in such a way that is understandable.
Hopefully, after reading this, you will think about how your order is being routed. And more importantly, is your order being front run by an HFT? Are you receiving the best available price on your stock trades?
Think about it.
Thanks for reading.
A really nice and enlightening article about Stocks fraud. Just a quick question: Which one is more fraud-prone? FOREX or US Stocks
Forex is definitely worse. The counterparty to all of your trades is the broker. Not other traders.
There is a multitude of ways a Forex broker can game their system.
I am all against Dark Pools (for HFT still not sure, they might in fact be adding liquidity and lowering the spread). But looking in to the IEX API, their spread is horrendous. For AAPL for example at 15:29, April 23, the bid was 164.76 and the ask was 167…. Any other place it was 0.01 cent… Not sure how this is a good thing… I rather be front ran for less than a penny, but get much better execution… In the end even though IEX is a good idea, their volume is like only 3% compared to the rest of the market…
saw the 6 traders via zh
It’s amusing there are some decrying Flash Boys; to whose interest; advantage ..
equally, John Grady in his basic course Bill XYZ .. hearing how ppl can push the mkt ‘higher or lower’ i always wondered..defending what? You’re there to execute a premeditated transactions – that’s it ..
i dunno if you can call dark pools exchanges ..they’re just that; like a dark ;p pool ..(bad analogy but) whisk away the stock if you want liquidity ..
i happen to know virtu well ..The thing is; that the more often you trade, your performance deteriorates ..
lol The leystrokes sounds like fb ..
Yeah your broker doesn’t work for the client ..
btw, i can’t recall/remember the name but you can now a la Kersner Trading et al. code for HFT ..
yeah; abt routing then you got your ECNs..i was expecting NASDAQ, ARCA, BATS, EDGX and EDA to see about them? This is like what my HFT firm did the way they train you .. if b4 the mkt opens the price is far away from fair value, you prepare baskets of orders yes like this you can send duplicates and get/profit off of each
*****a top rate article on the mysterious game of the HFTs*****
The main question is when Feds know what is happening, why are they not doing anything about it. Stopping such practices in futures market but allowing the same “legal ripoff” in the stock markets. May be the lobby is stronger in the equities due to the volume.
This might shed some light; http://www.youtube.com/watch?v=aq1Ln1UCoEU