Financial Warfare!
(and how the Stock Market is really a 21st century battleground)
I’ve just read an eye-popping article about computer hacking and its effect on trading… 
Jim Rickards wrote the piece and he’s been pushing some strong views for years: His vision is that a world war in modern times will not be won or lost on the battlefield… but in the financial markets.
He wasn’t taken seriously at first but it’s a different story now. Everyone is starting to pay careful attention to what he says.
Jim refers to deliberate attempts at destabilising a country’s economy as ‘financial warfare’. And since we’re all hooked up to each other 24 hours a day now, if you know which buttons to press on your keyboard it I guess it would be pretty straightforward to launch an attack of epic proportions right from a laptop at your kitchen table.
It’s why there’s a new type of elite soldier on the scene.
He no longer needs to be a muscle-bound trained killer. These days he’s just as likely a teenage computer hacker with the skills to sneak into a computer network on the other side of the globe and plant a silent but deadly payload.
So you might not hear a physical explosion when his covert computer code carries out its devious mission, but the results can be as devastating as a pound of Semtex!
And even high-security institutions leave their back door unlocked to those with the know-how to push it open.
Remember that English guy who carried out the ‘biggest military hack of all time’ a few years ago? Gary McKinnon hacked straight into NASA’s systems from his house in Scotland. Luckily he was only on the hunt for photos of flying saucers but imagine the damage he could have caused.
And here’s what Jim Rickards says about digital attacks on the markets specifically…
‘The most dangerous attacks of all are those in which the enemy penetrates a bank or stock exchange not to disable it or steal information but to turn it into an enemy drone. Such a market drone can be used by attackers for maximum market disruption and the mass destruction of wealth.‘
The FBI actually found one of these ‘enemy attack drones’ – a Russian one – sitting inside the Nasdaq stock market computers back in 2010.
There have also been numerous and highly suspicious mini crashes in the markets which have never been fully explained by the exchanges.
You see them all the time these days in stocks and shares. It’s not unusual to see a market sell-off insanely only to bounce back moments later.
They even have their own special name: flash crashes.
So it’s easy to blame the big players – investment banks and the like – for ganging up on us smaller guys, running our stop losses and costing us trades.
But are there actually more sinister forces at work in the markets?
What actually happens in a flash crash?
Flash crashes are a by-product of modern technology. Much trading at an institutional level is now done on autopilot: an algorithm is pre-programmed into a computer so it can think and trade for itself.
The idea is that the computer knows how many shares or contracts should be bought or sold when the markets behave in a certain way.
But if the market price can be manipulated – through fake or ‘spoof’ orders – it can deliberately trigger the algorithms on the first set of computer orders.
The snowball effect of these sell orders hitting the market then sets off a chain reaction…
The price drops lower triggering the next batch of computer orders; their sell orders come in and send the market lower again.
The market is crashing – fast – and any buyers in the market would understandably pull their buy orders at this point. They don’t want to be left catching a falling knife. And the sell-off gathers momentum and tumbles lower at ever increasing speed.
In theory it would only stop when all the computer sell orders are exhausted or when enough buyers eventually step in to match the selling pressure.
Could computer hackers really engineer all this?
Here’s Jim again explaining how they could do it and the effect it would have on the market: ‘An attacker could penetrate the order entry system of a major stock exchange such as the New York Stock Exchange or one of the order-matching dark pools operated by major investment banks, such as the SIGMA X system controlled by Goldman Sachs. Once inside the order entry system, the attacker would place large sell orders on highly liquid stocks such as Apple or Facebook. Other system participants would then automatically match these orders in the mistaken belief that they were real trades. The sell orders would keep flooding the market until eventually other participants lowered their bids and began to deflect the selling pressure to other exchanges. The result could be a market decline of 20% or more in a single day, comparable to the stock market crash of October 1987 or the crash of 1929.’
So this is the exposed underbelly of computerised trading.
At the moment, those institutions with the most powerful computers and the quickest connection to the exchange have an edge over all other market players. Processing speed is a mini arms race in its own right.
But it could all be rendered useless by a hacker in China with some smart coding skills and an old dial-up modem!
So what can be done about the threat of Financial Warfare?
Jim suggests a back-up plan…
‘I recommended that the SEC and New York Stock Exchange buy a warehouse in New York and equip it with copper-wire phones, handheld battery-powered calculators, and other pre-Internet equipment. This facility would serve as a non-digital stock exchange in the event of a digital attack. Orders would be phoned in on the analogue phone system and put up for bids and offers by the specialists to a crowd of live brokers. This is exactly how stocks were traded until recently. Computerised and algorithmic trading would be banned as nonessential. Only real investor interest would be represented in this non-digital venue. The U.S. would let China and Russia know this facility existed as a deterrent to a digital attack in the first place. If our rivals knew we had a robust non-digital Plan B, they might not bother to conduct a digital attack in the first place.’
Now I think it’s a bit optimistic to think the hackers would simply shrug their shoulders and slope off to find other targets just because a ‘plan B’ is announced.
But I do love the idea of an analogue exchange. It brings back fond memories of a simpler time when I used to fax orders in to my futures broker. And that wasn’t too many years ago either!
He also makes a valid point that an analogue exchange would cut out all the manipulations and spoof orders. They simply wouldn’t be able to push the stock markets around like they do at the moment with dummy orders placed and pulled inside fractions of a second as the computers try to outwit each other.
So it could even make for a refreshing change – a return to a ‘truer’ and more transparent stock market!
And on a personal level, do keep your wits about you if you’re involved in the US stock markets, even if you only spread bet the indices, especially if tensions continue to escalate between the US and Russia over Syria.
Be Prepared: Market Moving Data Coming This Week (London Time)
Wednesday 9th September
09:30 GBP Manufacturing production
Thursday 10th September
12:00 GBP Interest Rate Decision & BoE minutes
Friday 11th September
13:30 USD Producer Price Index
Monday 14th September
– no big reports
Tuesday 15th September
09:30 GBP Consumer Price Index
10:00 EUR German ZEW economic sentiment
13:30 USD Retail Sales
So we have quite a sparse week ahead on the scheduled reports front. There’s plenty of geo-political stuff going on elsewhere though. Like I mentioned above, the US and Russia are starting to square up to each other over Syria so keep an eye out for market reactions there as things develop there.
And there’s just been another chemical plant explosion in China. That’s four in the last few weeks! What on earth is going on over there?
