Update: Day Traders Crack The Timber Hill Trading System

This might be the first case ever when private investors  have managed to crack the algorithms of a large electronic marketplace. Norwegian police have filed charges against two day traders for using their computer knowledge to manipulate share prices in their favor. However, what they’ve been doing is in principal the same thing as the high frequency traders at Morgan Stanley, Goldman Sachs and the other banking giant are doing all the time.

“Well done boys! Keep it up.”

Anonymous

The two Norwegian private investors are accused of manipulating the share price of three companies  listed at the Oslo Stock Exchange between November 2007 and March 2008. According to the charges, they’ve placed orders and made over 2.200 transactions who gave  false picture of the supply and demand in the shares. By conducting an unusual amount of transactions in a short period of  time, they jacked the stock price up or down before taking profit.

Two Norwegian day traders are now facing up to six years in prison.

Christian Stenberg

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“We believe the two have committed a large number of price manipulations. They have placed buy and sale orders that have not been real.  They have had another motive; namely to move the prices,” says police lawyer Christian Stenberg with the Norwegian National Authority for Investigation and Prosecution of Economic and Environmental Crime, according to the newspaper Dagens Næringsliv.

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“In our view, it is a deliberately manipulation against the computer they’ve been trading against so that the system changed the prices and they were able to earn money,” he adds.

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The Heart Of HFT*

The two day traders, Svend Egil Larsen and Peder Veiby, managed to find a loophole in the global online broker Timber Hill’s stock trading algorithms.

Timber Hill is Interactive Brokers‘ key market maker, and used by many high frequency traders, providing anonymous accounts and access to liquidity pools.

Here’s how IB’s Sandler O’Neil describes their business on June 10th this summer:

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Pretty Clever

Peter Warren

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“Most trading robots are designed to find patterns and exploit them. If someone manages to discover the robots pattern, and utilize it, they have in principle done the same as the robot does,” says Norwegian market veteran Peter Warren.

“Many algo-systems have almost an intention to deceive the market. They trigger at different things and are either trying to create exchange rate movements, or price jumps in front,  as soon as they notice that something happens,” he explains.

“I would be careful to shelf these people because it is not yet clarified whether they have done something criminal, or not. But you’ve been pretty clever to find the pattern of such a robot, and utilize it,” Warren says.

That’s The Way To Do It

At one of the Norwegian online trading forums, one of the participants explains how the trading was done – more than 2.200 times:

Timber Hill Master Account

[Trader] One trader (Timber Hill) is in the book with a 5k bid at 9.7 and a 5k ask at 10.

[Trader] You buy 5000 “XYZ” at 10 from Timber Hill (TMB).

[Trader] Then TMB moves the bid to a 9,8 and the ask to 10,10.

[Trader] You buy 100 at 10,10.

[Trader] TMB moves to 9,9/bid and 10,2/ask.

[Trader] You buy 100 at 10,20.

[Trader] TMB moves to 10/bid and 10,30/ask.

[Trader] You buy 100 at 10,30.

[Trader] TMB moves to 10,1/bid and 10,4/ask.

[Trader] You buy 100 at 10,40.

[Trader] TMB moves to 10,2/bid and 10,5/ask.

[Trader] You buy 100 at 10,5.

[Trader] TMB moves to 10,3/bid and 10,6/ask.

[Trader] Then you sell 5500 at 10,3 (even if it shows only 5000, it’s hidden and takes the rest too).

[Trader] If you can short the stock, you dump 5k at 10,30/bid, and follow the same pattern on the way down.

[Trader] P/L

[Trader] 56650-55150=1500

“You can do this over and over again because Timber Hill doesn’t have a learning curve,” the trader points out.

The two Norwegians have allegedly manipulated the share prices of three companies listed at the Oslo Stock Exchange, making at profit of at least a quarter of a million Norwegian krone.

They have acted in the following companies: Hafslund (B shares), Wilh. Wilhelmsen and Odfjell (B shares).

Their trade amounted to a very high proportion of total turnover in these shares in the relevant period, according to the National Authority for Investigation and Prosecution of Economic and Environmental Crime.

The Econotwist’s Blog would like to point out that the system described above only works with shares that have a very low liquidity.

Illegal Or Not?

This story have certainly been the topic of the day amongst the Norwegian market participants.

It have also been noticed outside the 200 nautical mile fishery zone.

Tyler Durden at Zero Hedge comments:

“The irony is that as we have demonstrated repeatedly by showing prima-facie evidence from Nanex, quote stuffing patterns by thousands of HFT algos running amok across various US exchanges, ATS and other trading venues, is precisely what happens every single day in the US – namely, algos which merely seek to push the bid or the offer in a given direction, with no intent of ever crossing a trade, all for the sole purpose of sending false indications of bulk orders coming. So when humans do it (and make peanuts compared to the billions the HFTs collect domestically), they end up going to jail; when our own system, which is geared to push stocks ever higher, does it – it is perfectly ok, and possibly even encouraged. After all, the HFTs provide liquidity, remember? Just ask Mary Schapiro. The sad conclusion is that those who wish to trade in markets that have not yet been overrun by SkyNet, or where regulation actually works, may be best served by trading on the Oslo stock exchange, and as far away from the US as possible.”

Tor Arne Olsen

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As usual Zero Hedge makes some good points, but I have to remind Mr. Durden and everyone else that Oslo Stock Exchange also have some explaining to do in this case.

They were the ones who reported this case to the authorities in the first place.  OSE is in partnership with London Stock Exchange where Timber Hill is a member.

Tor Arne Olsen who is the spokesman for OSE will not disclose why they decided to report this particular case, E24.no reports.

Unexplainable moves in single shares happen all the time, usually followed by the obligatory half hour trading halt and a routine check, that’s it.

It’s a the fact that is Oslo Stock Exchange have a reputation for being a market with much illegal insider trading.

However, according to E24.no,  one of the accused traders have previously been involved in trades that have led the Oslo Stock Exchange to impose temporary trading halts to examine the price movements.

But it’s still unclear what the two investors actually allegedly have manipulated; the order book, or the share price?

That makes it an almost “legal impossible” case for the prosecutors.

Confessions of A Day Trader

Svend Egil Larsen

Svend Egil Larsen, one of the accused (and – by the way – brother of Mr. Ari Behn who is married to the Norwegian Princess Märtha Louise) is certain that he and his friend have done nothing illegal.

Mr. Larsen says he never tried to cheat the Timber Hill system, but after trading against it for some time, he discovered the pattern.

“It was pretty obvious,” ha says, according to DN.no.

According to the charges, Mr. Larsen and Mr. Veiby have been placing “fake” orders to pump up the prices.

Mr.Larsen, however, says they just placed the order to see what happened to the shares.

“My strategy is to exploit extreme movements,” he explains.

“For a day trader the situation is completely different today than just a year ago. There’s been extremely many robots trading at the Oslo Stock Exchange over the past year,” he says.

“Back in the old days you could sit and wait for the effect of a large sale, or a stop-loss or something, and then pick the shares that dropped. Today, a robot have already picked them –  you can not be fast enough, simply.”

Oslo Stock Exchange

In response to the question if he thinks the big trading robots are protecting the institutional investors at the expense of the private, he answer:

“If my name was Morgan Stanley, I don’t think you would be calling me today.”

General Equilibrium

There”s no question about who’s got the most sympathy.

The story must be one of the most commented in Norwegian online medias ever.

Here’s a little collection of statements:

* “How the hell can we earn money intraday if we are not smarter than then those f***ing robots? They’re everywhere!”

Day Traders

* “…and five minutes later, 10 cents more, then 10 more …. The entire stock rose a dime in half an hour? Do not punish them – shoot them!”

* “Well done boys! Keep it up.”

* “These charges are,  in my opinion, an evidence of that the prosecutors do not understand what’s happening in the stock market.”

* “The point is that it is idiocy to give robots control over money. It must be human control.”

* “Why don’t the police file charges against robot instead?”

* “You nailed it!  The next thing will be the Norwegian authorities employ robots who charge traders automatically if the trading robot loses money.”

* “All human day traders – let’s go on strike!!!”

* “This sounds like a planned murder of justice.”

* “There must be something more behind.”

* “The best to use taxpayer’s money is criminalizing ordinary people. There is nothing to be gained from chasing financial criminals or corrupt politicians …”

* “Is it April 1st today?”

* “If they’re convicted, it is hereby price manipulation to sell on the bid price when the previous trading was sold on ask. At the same time it will be manipulation to buy the on the ask when the last trade was on bid. Brilliant! We have met the general equilibrium.”

Timber Hill have not responded to the emails I sent them Tuesday.

HFT - What Could Go Wrong?

Related by the Esonotwist:

Living In A Derivative World

Testimony Of A High Frequency Trader

The Rise Of The New Market Makers

May 6. 2010: “The Black Thursday”

Thursday May 6. – Busiest Day Ever On CBOE

Wall Street Collapse: Did Somebody See It Coming?

U.S. Stock Crash Compels Further Investigation of Wall Street Scam

Robots Gone Wild On Wall Street

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12 Comments

Filed under International Econnomic Politics, National Economic Politics

12 responses to “Update: Day Traders Crack The Timber Hill Trading System

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  9. Jim Davis

    The real story here is why was Timber Hill trading so stupidly? Lifting the bid and offer of 100 share trades is ridiculous. I have to assume this was some sort of bug in the market making code that has long been fixed.

    If they had routinely traded like this on all markets, they would be out of business long ago.

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