Eric Hunsader: Investors Need to Realize the Machines Have Taken Over
In the blink of an eye, the market moves what used to take humans thirty minutes.
High frequency trading (HFT) deeply concerns Eric Hunsader, founder of Nanex. He worries that today's investors, our regulators – heck, even the HFT algorithms themselves – don't fully understand the risks market prices face in the brave new era of bot-dominated trading.
For instance, Hunsader estimates that HFT algorithms are responsible for 70%(!) of all completed transactions on our exchanges, and for 99.9%(!!!) of all exchange quotes.
The pictures of trading floors you see on TV, where the people in bright jackets appear frantically busy in making their trades, have no bearing – claims Hunsader – on the actual trading action. The real action happens across fiber-optic cables, on racks of servers in cooled rooms, where an arms race defined by cable length and switching speeds is being waged
The reality is that the machines have taken over. When you buy or sell a security, the odds are extremely high that the other side of the trade is being placed by an algorithm – one that cares nothing for the fundamentals of the underlying instrument. It simply is looking to make a quick profit, oftentimes measured in fractions of pennies. And this has vast repercussions for the stability and the fairness of our financial markets.
Because of speed advantages, HFT algos can see and react to prices faster than you can. Ridiculously faster. A second on the clock, to an HFT algo, is an eternity.
The deep pockets of the firms employing HFT algos combine with this speed to move asset prices around, sometimes wildly so, faster than most of us can comprehend. In the time it takes for your "real-time" quote system to refresh, an individual stock could have traded many percetages up and/or down – and you would have no idea.
This unfair advantage, along with the short-term profit outlook of the algos, creates the potential for deadly market price downdrafts. Algorithms prefer predictability. If something spooks them (e.g., unexpected breaking news; a delay in the market's opening), they simply stop trading. And – poof! – 70% of the market has just disappeared. With no support and no bids, prices can drop dizzyingly fast. Making matters worse, the "smarter" algos can recognize a downdraft in process and begin piling back into the market on the short side, exacerbating the price declines.
The Facebook IPO provides a recent example of the vulnerability of our system:
Eric Hunsader: If we get one bad, unsuspected news event, I guarantee you it will be lights out very quick. One of the things these algorithms do is they make sure the input is good. And whenever the input isn’t quite good, they back off. When I say back off I mean they back off in the blink of an eye. So it can go from good to very bad that quickly. And all it's going to take is some unforeseen news event and they won’t be there. And then we’ll see what the liquidity is.
Chris Martenson: So do you see this on a daily basis or some frequency where you see volumes or liquidity just suddenly dry up in the market?
Eric Hunsader: Yes. For example, on the Facebook IPO day, NASDAQ was trying to open the IPO up. By their third attempt, they’re telling everybody Wait, we’ll get it at 11:05. No, we’ll get it at 11:10. No we’ll get it at 11:30. So it was do-or-die time, 11:29:50 comes around. Somebody there has the bright idea to just reboot the system. It takes NASDAQ offline a full seventeen seconds. Nothing coming out of NASDAQ. Not a peep in any stock, market-wide, for seventeen seconds. When NASDAQ finally did reappear, what happened? The orders that were resting in the book all that time immediately disappeared. Like 60%-70% of all liquidity within 200 milliseconds was gone: SPY, Microsoft, Apple. Not just Facebook – it was every stock. We were extremely vulnerable over, I would say, that fifteen to thirty minutes to any sudden external shock. And we usually get away with it, but one day we’re not going to get away with it.
Chris Martenson: So seventeen seconds of going dark for one of largest exchanges out there. That must have been several lifetimes for these algorithms.
Eric Hunsader: Seventeen million microseconds.
Chris Martenson: Seventeen million microseconds; that’s forever.
Eric Hunsader: It is forever. And that’s why we see the liquidity and all these books just go – poof!
In this podcast, Chris and Eric analyze a mini-crash in oil futures, where the price of oil (a huge market) dropped $3 within a single minute, at tremendous volume. The chart below shows the price action in the USO ETF during that period for 1 millisecond (that's 1 one-thousandth of a second). Click the play button to hear a tonal articulation of the trade volume for that period (each tone represents a trade; trades made at a lower price have a lower tone):
By the way, this action is for a single exchange – there are 13 in total. So you get the sense for the tremendous amount of trading activity that HFT algos generate in just 1 millisecond. Try to conceive of what the activity volume is in a second, a minute, a hour – it's mind-boggling. No wonder the regulators are so ineffective.
Is the presence of these HFT algorithms aiding with true price discovery? Quite the opposite, says Hunsader. Instead, HFT has made our markets unsafe – especially for the individual investor – as big institutional players, unchecked by our regulators, use their unfair advantages to fleece those without:
A lot has to do with the regulator not being in the room just clarifying some basic ground rules that are already in place. I mean, a lot of the tactics and things that go on now, if they tried to get away with this face-to-face in the past, somebody would be walking away with a black eye. People just don’t put up with this poor behavior. But the market is set up anonymously. So you don’t know if it's the same guy who hit you really hard the other day at your tipping point. I mean, 'everything goes.' And without a regulator or any sense of a regulator ever doing anything about it over time you get this creeping in of You know, we did that before and nobody ever said anything. So let’s try this. And that’s what happens. You just get this slow creep of a drop in ethics.
Click the play button below to listen to Chris' full interview with Eric Hunsader (34m:58s):
Chris Martenson: Welcome to another Peak Prosperity podcast. I am your host, of course, Chris Martenson. Now on May 6, 2010 the Dow Jones Industrial Average had plunged by a thousand points, about nine percent, only to recover those losses within minutes. It was the second largest point swing on record, the biggest 1 day point decline of nearly a thousand points. On the intraday basis in the Dow Jones Industrial Average history it was incredible. It was an incredible moment. Now, the SEC and the CFTC they spent months investigating this because it was a horrendous event. And they ended up pinning the blame on a single mutual fund operating out of the Midwest for posting a trade in the e-minis, that’s the S&P e-mini contracts, that apparently exhausted all available buyers which then triggered and avalanche of high frequency trading or HFT algorithms that piled on. Now could such a crash happen again? Is this what really happened? Are our markets more or less safe than they were back then in May of 2010? At a higher level what does the rise of HFT trading mean to the very functioning of our markets? Do their strategies and tactics efficiently allocate capital or are they more like parasites operating under the fiction of providing liquidity but really just vacuuming pennies from every trade only introducing fragility and volatility into the market structure. Now to help us make sense of all this today we’re talking with the founder of NANEX, Eric Hunsader, which is a company that provides exchange reporting and delivery of whole market data feeds. Eric has twenty-five years of hands on experience developing trading software including high performance trading applications. Hey welcome Eric, it's really great to have you with us today.
Eric Hunsader: Thank you very much for having me.
Chris Martenson: Fantastic! So Eric I now see the world of HFT, this thing that’s collectively now called HFT. It's kind of like a universe of it's own. It has it's own rules. It's comprised of both software robots or agencies, algorithms, and hardware, the routers, the switches, cables, pipes, channels, all that stuff. And together the software and hardware have become something of a playpen where you really had better know the rules if you want to climb in and play. Can you please give us your views on, first, how this universe operates and maybe a few of the most important things every investor ought to know about it.
Eric Hunsader: Okay, so if you’ve ever watched CNBC and you saw the guys with the colored jackets on the floor that’s actually just a showroom. The trading today takes place in a rack of servers in a nice air conditioned cooled room where all the high frequency traders fight about how long their cable is, their cable connection is to the exchange.
Chris Martenson: And why does cable length matter?
Eric Hunsader: Well, because speed of light can only go so fast. For example, down an eight thousand foot cable it takes about one microsecond for it to traverse that distance and if somebody has a five hundred foot cable, well, they just saved a half a microsecond, which actually matters to these folks.
Chris Martenson: So we’re now in a world where if you are a half of a microsecond, that’s a millionth of a second, if you’re a half a microsecond behind somebody else you might be at a disadvantage.
Eric Hunsader: Yes.
Chris Martenson: Really?
Eric Hunsader: Absolutely, yes. It's all about being at the top of the Bid-Ask spread.
Chris Martenson: Well, at business school they taught me all about efficient markets and the sufficient market hypothesis which says that all traders have – that all information is basically equal to all players. And what you’re saying is that information has nothing to do with it in this case in the sense of what the fundamental information is. It's the speed at which you gain access to that information. There’s no longer symmetry in that equation.
Eric Hunsader: Right. It’s – what happens during the day or these sudden blips you see have nothing to do with economics.
Chris Martenson: These sudden blips. You mean like where stocks will suddenly just spike and plunge all within a very short frame of time and something is happening there but what is happening there?
Eric Hunsader: Well, a number of things. It could be news reader algos misread. It could be one algos figured out how to tricker another algos into buying or selling. And then other algos see that and they are tricked too, and they’re fooled, and they all follow the leader. It's like a pack of lemmings except the first lemmings in the line always make out, the ones at the end are the ones who end up paying.
Chris Martenson: Hmm…you know they have these toys for kids now where they’re these little blocks that have different rules baked into them. And it seems simple enough, right? There’s just a couple of rules in one of these blocks but when you start combining them the rules interact with each other in really kind of unpredictable ways. So it sounds like you’re saying there are these algorithms running around. Each one has it's own little set of rules. One’s trying to – looking for either a speed advantage or maybe one is looking for a way to trick another algorithm or they’re inserting quotes and removing them but they have a set of rules and when you put all of them together they’re actually interacting with each other’s rule sets. Is that close? Is that what’s happening here?
Eric Hunsader: Yes, that’s right. And if a microsecond matters that means that your algorithm can’t go out and have a sanity check, what we like to call in the software world just to see is this normal for Microsoft to be trading at a third of the price because that check involves not a microsecond but thousands or actually millions of microseconds and nobody’s going to do that. So you end up, all the algorithms are being driven off of really bogus prices.
Chris Martenson: Alright, so…
Eric Hunsader: Like for instance, what’s interesting – which makes all the interesting observations we see.
Chris Martenson: The interesting observations, so let’s – where you started with this, we’ve got these people in these brightly colored blue and gold floor jackets and they’re all waving around and whenever the market does something like a flash crash they always show a picture of these people as if somehow there were people involved but what you’re saying is that most of the action is now happening across fiberoptic cables, on racks of servers in cooled rooms with the shortest possible cable lengths and the fastest possible switching equipment. That’s really where most of the action’s happening.
Eric Hunsader: In the blink of an eye the market moves what used to take humans thirty minutes…
Chris Martenson: In the blink of an eye.
Eric Hunsader: There’s no way those people with the floor jackets have any bearing on the actual trading.
Chris Martenson: Alright, so we just had a very interesting ruling recently. I guess the SEC did something that’s never been done before. It levied a five million dollar fine against the New York Stock Exchange’s parent company for the act of providing valuable trading information to some clients ahead of others. So what was happening there?
Eric Hunsader: Well, that’s just it, we have these regulations in place, they’re called Reg NMS, it's a pretty thick document, and it was debated by the industry. Everybody had a say so in it. They talked about it for a year. They passed it in 2007. And one of the rules is that exchanges cannot give data to certain, some, people faster than what’s called the consolidated feed which is the consolidated feed is where the prices, the true prices, reference prices are. And the exchanges wanted to sell these private feeds and they want to sell it for lots of money and one of the key points that the sales guy will tell you is that it's faster but the regulations clearly say you can’t do that. Well, the SEC finally got around to enforcing something that has been going on for years.
Chris Martenson: Five million dollars, is that actually putative in this case or is it a fraction of the kind of fees they might have been earning from this practice?
Eric Hunsader: Exchanges earn about a half a billion dollars a year in exchange fees for the consolidated quote. So the consolidated quote, the one that they’re supposed to make sure updates the fastest, they collect a half a billion dollars a year on.
Chris Martenson: Okay, a half billion…
Eric Hunsader: That’s the perspective.
Chris Martenson: Alright, so we have a hundred to one, sort of relationship here between the fee structure and the fine. With this fine that happened, did the SEC provide any sort of an injunction against this practice or put any new rules in place? I mean the rules were already in place. So what happened besides the fine in this case?
Eric Hunsader: Well, more important than the fine they reaffirmed provisions in Reg NMS that we have been talking about for years now this whole business of not updating the consolidate quote or not having an incentive to. And the SEC very nicely reaffirmed that that is indeed what Reg NMS says. So the SEC has opened the door up here to a lot more issues where the consolidated quote doesn’t get the attention it needs.
Chris Martenson: When I was talking with Joe Saluzzi about this a while back he mentioned that there’s certain firms that have been operating in this space, in the high frequency space, which had basically winning records for years meaning that like they’ve literally never had a day of losses. They just have these algorithms that are that efficient. So I assume that the people that would be fighting these sorts of rules and rule sets would be the firms that are making all this money. Is that a fair statement?
Eric Hunsader: Yes, they fight over a five hundred foot cable. You bet ya they’re going to fight over this.
Chris Martenson: We can talk later about the market structure and how this might get fixed. I’m really intrigued that the SEC has finally said, oh my gosh, there’s something here that’s happening. That’s a great first admission. It's a great first step. But it seems like too little too late in some respects. I want to go back into the flash crash. This should have been a giant wake up call. It was not just a shot across the bow. It almost felt like a shot into the water line. So back in 2010 I think you have some of the most interesting findings, and I think the best and most comprehensive description of what really happened on that day. In your own words, what happened? What was the initiating event and what actually happened on that day?
Eric Hunsader: Well, there’s a lot of similarities between the flash crash and what we just saw recently in crude oil. You basically have fundamental sellers out there who were watching the news and were reacting and they’re hedging their portfolios. And you’ve got these market makers, these high frequency trader, market makers, who tend to dampen out prices. And they were accumulating and accumulating, and they got to their tipping point where they weren’t willing to take on anymore contracts. And when they get to their tipping point what they do is they take their entire inventory and they sell it as fast as they can. And they can do this very quickly. And not only do they sell it as fast as they can but they know that they’re selling is going to impact the market. So they go short as well. And so you’ve got normally what they would dampen the market out, they would normally dampen price swings out but every once I a while the price swing gets just a little too far. It doesn’t just break down. It gets destroyed, it gets decimated. The market just immediately has to absorb all of the contracts that they were accumulating during that period of time. And when they did that, unfortunately, they hadn’t been paying attention to the consolidated quote system. They hadn’t been upgrading it and we hit levels that it just had never experienced before and couldn’t take the load and to the point where CNBC when they were screaming Armageddon, it's the end of the world on national television, the actual prices in the market on that flash crash day had already returned to the levels before the drop. In other words, they were screaming it was the end of the world and the market had already recovered. What a disconnect the information was on that day.
Chris Martenson: So what I’m trying to understand here is we have these algorithms that are in there and while they’re in there they provide this appearance of liquidity and, indeed, they’re a huge portion of the overall market structure at this point and yet, on the day of the flash crash what seemed to happen was, as you mentioned it, there’s this market maker, they accumulated as much as they possibly could, and then just in the blink of an eye or even shorter, that breaks, they flip around, all of a sudden they’re selling out of their position as fast as they possibly can, even going short to amplify that a little bit. And of course, all these other algorithms are out there sniffing that and they’re following along because a lot of them do that. They follow the trend beautifully. Our markets now though, I’m just trying to get my hands around two things then. How much of the market were HFT algorithms in terms of volume back in 2010 and how much are they today? Where are we really in this story?
Eric Hunsader: Well, they are 99.9% of the quotes that we see which are not completed transactions, and they are approximately probably seventy percent of the completed transactions. If we go back in time we see their footprints really show up in the middle of 2007. And it's been pretty much a linear growth from that time to now. There wasn’t any ever one period where it was sudden acceleration. It's just continues to grow.
Chris Martenson: Yeah, 2007 mid is right around where a lot of my personal trading strategies started to breakdown. And I know other traders who had been very successful in the markets for a long time also started to get their pockets picked is the actual description of that. And it took me about a year to realize that I no longer could play in that market. So one of the impacts personally for me of the rise of HFT systems is that I no longer trade. And I can’t – I just – it's not – there’s things that happen in those markets where limit orders don’t work and market orders don’t work, and all the usual structures that I had to protect myself didn’t work at least from a day trading or even a midterm trading strategy standpoint. So I got driven out of that market but other players with deep pockets apparently have stepped in into that place because we’ve had this nice, linear growth. And so here we are. The fundamental question I guess for me then is that it sounds like, A, with ninety-nine or more percent of the quotes being provided by HFT, seventy percent of the completed trades volume being provided that in your estimation then the exact same circumstances that sort of were there in May of 2010 sound like they’re still with us, maybe even more so.
Eric Hunsader: Yes, and that’s because ever exchange of the thirteen exchanges that we have now, not including the dark pools that trade the stock, they’re only interested in making sure their systems work for that exchange. There’s nobody looking at the aggregate making sure that all thirteen of them interacting with each other are causing issues. And a very good example of that recently was when NYSC wanted to compete with the dark pools and the wanted to have the public orders be routed separately so that they could mark them. That’s a whole other topic. But essentially they made a request to change the information they sent to the consolidated quote that effectively doubled, fully doubled the traffic or the amount of information and they were only concerned about how that affected their allocation. So they essentially took away a half of the total network allocation and had no concern over how that might impact others or if we have a very active day.
Chris Martenson: So we have thirteen exchanges, each of them has their own autonomous sets of rules that seem to work well for them probably within normal parameters they do work well. The markets seem to function everyday but what you’re saying is there’s the potential here for feedback loops or anomalous behaviors that can span across these exchanges. Nobody’s really looking at all of that and potentially that’s even beyond, if I could interject some, an idea, that’s beyond the ability of the regulators to really regulate because they actually can only really sort of regulate after the fact, I guess.
Eric Hunsader: Well even that’s questionable. I mean we told Greg Berman and his group at the SEC in Washington in July about these delays in the NYSE system. This is the same exact delay that NYSE was just fined for just now. I would say that was a very simple thing to find, very trivial, in fact, compared to what’s happened since then. Everyday the market can often generate as much information as existed on the flash crash day.
Chris Martenson: Wow.
Eric Hunsader: If we get one bad, unsuspected news event I guarantee you it will be lights out very quick. One of the things these algorithms do is they make sure the input is good. And whenever the input isn’t quite good they back off. When I say back off I mean they back off in the blink of an eye. So it can go from good to very bad that quickly. And all it's going to take is some unforeseen news event and they won’t be there. And then we’ll see what the liquidity is.
Chris Martenson: So do you see this on a daily basis or some frequency where you see volumes or liquidity just suddenly dry up in the market?
Eric Hunsader: Yes.
Chris Martenson: Is this market wide or in certain issues or how precise is that statement?
Eric Hunsader: Well, it depends on what – if the input’s bad those issues will be affected. For example on the Facebook IPO day, NASDAQ is trying to open the IPO up, they have a third attempt, they’re telling everybody to wait, we’ll get it at 11:05. No, we’ll get it at 11:10, no we’ll get it at 11:30. So here is do or die time, 11:29:50 comes around. Somebody there has the bright idea to just reboot a system. It takes NASDAQ offline a full seventeen seconds. Nothing coming out of NASDAQ, not a peep in any stock, market wide for seventeen seconds. When NASDAQ finally does reappear what is it, what happens? The orders that were resting in the book all that time immediately disappear like sixty, seventy percent of all liquidity within two hundred milliseconds is gone, SPY, Microsoft, Apple, not Facebook, or well, it was Facebook as well, but it was all, every stock. We were extremely vulnerable over, I would say, that fifteen to thirty minutes to any sudden external shock. And we usually get away with it but one day we’re not going to get away with it.
Chris Martenson: So seventeen seconds of going dark for one of largest exchanges out there, that must have been several lifetimes through these algorithms.
Eric Hunsader: Seventeen million microseconds.
Chris Martenson: Seventeen million microseconds, that’s forever.
Eric Hunsader: It is forever and that’s why we see the liquidity and all these books just go poof.
Chris Martenson: Poof, so the liquidity just dried up instantly in that. Recently I helped illustrate this. I had this chance to review some data that you provided about a specific set of trades I was interested in. It happened over just a few minutes on September 17th, 2012. It involved the oil markets. I was interested in the main crude oil futures contract and I was watching oil plunge a little bit more than three bucks in about a minute starting at about 1:54 pm on that day. Volume spiked to twelve thousand five hundred contracts where normal contracts might be maybe five hundred. And as you showed in your data though it wasn’t just that front month oil contract that I was interested in but the associated ETF USO options, and looking into other markets, gold got involved, copper, even the Euro, all got swept up in this storm. And what I saw in the data you provided really confirmed my views and it deepened my concern about how these markets function because when I’m looking at my quote feeds over here, and it's just so ridiculously slow. I mean I’m watching stuff with one minute resolution, which is I don’t know how many microseconds is that. It’s sixty million of them or something. It's some big number. What I saw in your data was a big stream of oil contracts being dumped by what you suspect was a single entity because you could look at the data and see the sequential referential numbers, reference numbers, if I have that right. I saw these contracts being dumped so fast that the graph had to be plotted at the millisecond time scale to even see them. A couple things drive me nuts about this. The first is after the fact that the people on CNBC and Wall Street Journal, they say oh, an investor was doing something or it looked like they describe it to investors but you had to look at this at the millisecond time scale to even make sense of it. So let’s just talk about what we saw in that data that day because I think it really tells the story nicely about what’s really happening. I mean when the oil market is the biggest, most liquid market out there, and here we saw a single entity coming in and just dumping contracts. What – talk to me about that. Let’s just flesh this one instance out because I think he does a great job explaining what’s happened here.
Eric Hunsader: Well, I think, again, you had a market maker who is taking it, was absorbing the selling and they were absorbing and absorbing for a while. And they got to their breaking point. Let me ask you having traded the markets. If you’re about to dump your whole position and you know it's going to really knock the market hard what’s your first instinct? Are you going to go and sell the USO and everything else you can get your hands on that’s also going to drop?
Chris Martenson: Absolutely. I’m going to have to hedge that and get short as fast as I can because I’m going to get bad prices when I dump.
Eric Hunsader: That’s exactly what happens and that’s exactly what happened on that day. They just got to their breaking point. And here’s an interesting thing, if this can happen that means that other high frequency traders or groups are going to say, hey, you know what. If we can detect when somebody’s getting pretty full and is about to hit their breaking point we could cause them to break first. We could hit them hard at a key moment; a hundred contracts at the right time when we know there are almost ready to flip over we could be the ones selling all the other contracts. We could be the ones who sell first. And hence, this is the game that’s played.
Chris Martenson: But maybe all few hundred milliseconds earlier I’m going to wander over and grab myself a whole bunch of puts or I’m going to grab a nice short position in USO or I’m going to understand that these are correlated markets now. I could actually span other markets and grab short positions there too. And so then these become amplifying behaviors.
Eric Hunsader: Correct.
Chris Martenson: Well, so here we have an instance where hundreds of billions of dollars in notional value suddenly evaporated because one market maker got to their choke point, they dumped, all the algos sort of fire along. Is this now – is this a typical or an atypical example about how our markets are working? I mean I’m generally talking equity markets. This could be individual shares, whole markets, ETFs, I mean is this – do you see this kind of thing happening pretty routinely now?
Eric Hunsader: Yes and a lot has to do with the lack of diversity of participants, you not being in the marketplace anymore with different point of views. When you have all these algorithms that are all teeing off with the same data, and the same information this only happens more frequently.
Chris Martenson: Alright, so we’ve got these huge risks now, you say, standing out there. One could be that a news event comes, it puts the parameters out of acceptable boundaries, and all of a sudden we go from good to bad in a blink. Liquidity just can dry up in a couple hundred milliseconds or less. And we’ve got this volatility now where we have these self-amplifying behaviors. Many people say that because these HFT algos are pretty well funded and there’s a lot of capital behind them that they are providing a lot of liquidity. Where do you stand on this? Is this providing important benefits, good price discovery, or something else?
Eric Hunsader: Something else entirely. We passed that point and a lot has to do with the regulator not being in the room just clarifying some basic ground rules that are already in place. I mean a lot of the tactics and things that go on now if they tried to get away with this face-to-face in the past they would – somebody would be walking away with a black eye. They just – people just don’t put up with this poor behavior. But the market is set up anonymously. So you don’t know if it's the same guy who hit you really hard the other day at your tipping point. I mean everything goes and without a regulator or any sense of a regulator ever doing anything about it over time you get this creeping in of, well, you know we did that before and nobody ever said anything. So let’s try this. And that’s what happens. You just get this slow creep of a drop in ethics.
Chris Martenson: Well, now I heard recently that Germany took a peak at all of this and said nein. They are wanting to put some really serious curves on the practices of HFT. If we were going to do that at the regulatory level what kind of things can or should we be doing there?
Eric Hunsader: Well, I think simply enforcing Reg NMS, if I were the regulator, if I could be the regulator for a month the first thing I would do is I would go with a Reg NMS and I would have a round table discussion and I would reaffirm all of the things that are in there, and say look guys, this is how it's spelled out. So if we find you doing any of these things you’re going to get fined, period. And I would let that work it's way through the system for a good six months to see what the impact is. I have a feeling a lot would clear up pretty quick. But if we did need to do anything about putting the brakes on, a lot has to do with transparency or anonymity. If I, for example, going back to my pit analogy. If I know that that one guy is not to be trusted just like the pit would not want to trade with him, I wouldn’t want to trade with him. So if we had some indication that somebody’s quote that they put in the system might not be there when we need it, if they simply mark it that way like, look, this quote, we’re just throwing it out here. We don’t want it – we want to be able to cancel it on a whim a microsecond later. Fine, mark it that way, put a little indicator on that quote saying so. So that if somebody else puts a quote in the system who really wants to buy or sell, well then we know that and then the market place can evaluate which quote has more value.
Chris Martenson: Hmm…and I’ve heard other potential rules like putting an actual time delay on these things so that a quote has to either be persistent for a certain length of time or maybe other ways of just putting maybe some speed bumps in this. Would those be useful things to do?
Eric Hunsader: Well, we think – again, in my last illustration there is a speed bump. If you put in a quote and you don’t mark it saying that this might disappear at any moment you have to keep it in there for fifty milliseconds, period. If you want to be able to cancel it in fifty milliseconds you have to just mark it that way.
Chris Martenson: Okay.
Eric Hunsader: And that will work for the existing infrastructure. See, we don’t need any taxes, we don’t need any new rules, we don’t need to change any software in the industry, we can do that with existing infrastructure. In fact, they used to have this concept of a non-firm quote not too long ago, and that’s exactly what these are. In fact, Reg NMS, the very document that I’ve been talking about called them flickering quotes. So they already have a name and they’ve already been talked about, and we already know that the flickering quotes the other exchanges don’t have to honor. I mean it's already spelled out. We just need somebody to go – to become a regulator.
Chris Martenson: Okay, so we’ve – it sounds like we’ve already done the work. We’ve understood the system and what needs to be done. We’ve actually even talked about it and passed the regulation. So everything’s in place except the enforcement. Is that fair?
Eric Hunsader: Yes. And until two weeks ago I thought that would never happen.
Chris Martenson: Ah, with a five million dollar fine but it's a start, right?
Eric Hunsader: It's the fact that they went and they highlighted the portions in Reg NMS and they clarified what they meant. That is much more valuable to me or what I think to the marketplace than the fine itself.
Chris Martenson: Now, if I could this is where it gets really tricky. So for the individual investor who’s looking at this saying, gosh, I have money in the market. I’ve got pension funds, I’ve got 401Ks, I’ve got individual stockholder. I’m in the market. It sounds like the potential for a flash crash event still exists or something where the flash crash was basically happened and then it was over even before the news casters could figure that out. It sounds like there’s the potential for something to happen which crashes things and sort of stays that way. How would I protect myself against this market structure as it exists now?
Eric Hunsader: Well, that’s a good point you bring up about the flash crash. People who went out for a cup of coffee at that moment had as long as they didn’t have any software just sitting in the market it was almost a non-impact. But if it happened in the last ten minutes of the day where there are no circuit breakers in place the time of the day which is being gamed more and more and more as we go on, yes, it definitely exists that we have some event right on the close that sets the tone and the mood. Just like the butterfly effect it doesn’t take much to – it's all about perception and the valuation in the marketplace that depends on perception contains quite a bit over night, and that could set it off.
Chris Martenson: Well, if something happens in the last ten minutes and you have a big sort of price reset to another point there’s plenty of time for margin calls to go out which has it's own sort of ripple effect at that point in time. So it has a much better chance of sticking, plus setting perceptions, plus bleeding into other markets that are happening as the globe spins. So it sounds like that we’re really still at risk from either the opening or the closing bell the first few minutes before and after those events. So again, how does the individual investor protect themselves in that environment? It doesn’t sound like…
Eric Hunsader: Well, just like always. You never – in the past you never knew war would break out and that can – that has nothing to do with high frequency trading. I mean it's all about diversification. And one of the things that really irks me is this whole business, you’re told by the regulator not to use stop orders or market orders. Well, what kind of a market do you have when you can’t use a market order? I mean that right there should tell anybody that we don’t have a market. If a market order is something that you’re going to get horrible fills on then you don’t really have a market.
Chris Martenson: That’s a great point. Alright, so I do think that at your site you’ve got just an extraordinary amount of information detailing all of these sort of anomalous things that happened on a daily basis. You’ve got some really nice examples there. And so I really want to thank you for your time and if people want to read about what you’re discovering and what’s really going on in the markets where do they follow you and…
Eric Hunsader: On www.NANEX.net
Chris Martenson: NANEX…
Eric Hunsader: NANEX.net, yeah…
Chris Martenson: www.NANEX.net and once they get there what would you direct them to read?
Eric Hunsader: Well, I mean I they want to have the same tools that the SEC is going – is about to spend millions of dollars and wait years for our customers have those and have had those capabilities for years now. So if somebody’s interested in really digging in and putting on a regulator hat and seeing what we see they would, they could subscribe to our product. But we also put out a lot of research, and this is all about trying to educate – actually it's about educating the SEC to just simply enforce their regulations, and one of the links on there is for NANEX Research. And that’s what that is.
Chris Martenson: Yeah, I’ve spent some time digging around in there. There’s all kinds of charts and graphs and you can see these shenanigans, if we could call it that, happening at the millisecond time scale. It's just – it's a phenomenal world and I think today you have to understand that that is the world if you want to be in these markets in one way or another. It's an important development. It's something we’re still getting our minds and hands and ideas around because, again, footprints first detected in, say, 2007. So we don’t have that much experience with it. and in between 2007 and now we’ve had one pretty awesome flash crash but there are mini crashes that happen almost on a daily basis on individual issues, shares, across ETFs, you name it. And that’s just where our market operates now. So I really…
Eric Hunsader: Well, the flash crash is actually the second one. There was also one on September 29th, 2008 where the Dow Jones lost five hundred points in about five minutes and then recovered again, which is fascinating parallels to the one on May 6th.
Chris Martenson: Yeah, you know, I was actually actively trading SPY contracts at that moment. That was a painful moment for me.
Eric Hunsader: Yeah, so on that day though the quotes got delayed for hours actually. In fact, NASDAQ’s about putting out a valid quote from 2:00 in the afternoon until the close but they traded just fine and that’s because they’re premium customers illegally were getting their direct feed.
Chris Martenson: Yes and I was not in that preferred inner circle so it was a painful moment for me.
Eric Hunsader: Right but you were protected. You don’t have to be in the inner circle according to regulations, so that was a puzzle.
Chris Martenson: Right, so much for the efficient market hypothesis. It breaks down when we get into the quantum world of high frequency trading and preferred customers. Well, thank you so much Eric. I really appreciate your time in mostly what you’re doing to educate and to try and bring some order back into our Wild West markets. Thank you for that.
Eric Hunsader: You’re welcome and thank you for having us.