Guest Post: Nanex: Investors Need To Realize The Machines Have Taken Over

Tyler Durden's picture

Submitted by Adam Taggart of Peak Prosperity,

In the blink of an eye, the market moves what used to take humans thirty minutes

High Frequency Trading (HFT) deeply concerns Erik 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 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 emplying 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:

Erik 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?


Erik 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.


Erik Hunsader: Seventeen million microseconds.


Chris Martenson:  Seventeen million microseconds, that’s forever.


Erik 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):


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Mr Lennon Hendrix's picture

Rise of the Machines

The Illuminists want us to believe their will be a world where we lie happily in our graves, sipping lemonade, while machines make us money by trading AAPL for FB and back again.  China will sew our clothing, Africa will mine our ore, and the Middle East will produce our oil - at least until we wreck our habitat by fracking and tapping the Rockies.

Our work will be done by simply putting out our hands and like paupers we will get the change we need to maintain our status quo.  We sell buy phones from T and shoes from NKE.  We have a system and it works.  The system is like living in DIS:  the bumbs on the street are the Seven Dwarfs, the frat boys are Aladdin, and the Sorority girls are Sleeping Beauty.  We all have roles in this system, and the machines know best.

Long-John-Silver's picture

All your money will be assimilated.

The trend is your friend's picture

So in hyperspace thier is no need for real money either i guess.  You can run a algo to constanstly trade back and forth in such high speed that every stock just levitates in the same place and never needs to go down

Mr Lennon Hendrix's picture

But with an increasing debt load and an increasing currency supply everything else in these terms will increase in price due to dollar supply/demand constraints.

An increasing supply of a good with either a falling or steady demand will decrease the good's value:  this is what is happening to the dollar and all fiat currency.

This and given the fact that fiat has no intrinsic value, well....

....on a long enough timeline....

ptoemmes's picture

In hyperspace, no one can hear you scream.

Muppet of the Universe's picture

you know everyone curses the machine revolution.  But I do not think they understand the importance of evolution.  mankind is, seriously flawed. in its current state it is doing nothing, and destroying the world at the same time. only very few are actually accomplishing useful works.  mankind must be upgraded, or destroyed.

IndicaTive's picture


"We all have roles in this system" And today. Just today. While my kids are at their whore mother's for one night out of the two per month that she can be bothered with them, I'm going to drink whiskey, hang out with the dog and maybe go up into the attic and find the teotwawki vac sealed jar of killer bud. That's my role. Today. Fuck this shit.

Jack Burton's picture

Love that post! You made my day.

GMadScientist's picture

One of many important crops in the old "victory garden".


RiverRoad's picture

Hal's running the show but as Mark Cuban says, "All machines have bugs."  So End Game.





GMadScientist's picture

Ah, but who planted them, and who's listening?

Oh, you didn't mean the Tammany kind.

" We still love you, Mitt" - "the 47%"

americanspirit's picture

Resistance may be futile but it is the only viable human response, the only question is - what is the most effective form of resistance for me. And for you. And you. It doesn't matter if the most effective form of resistance isn't even very effective. It is the only viable human response.

Middle_Finger_Market's picture

Fuck the system and fuck the machines. We are going to war baby and only 10% of the population survives.

reader2010's picture

Fuck Yeah. Super Bullish.

knukles's picture

I'm sure glad somone has a positive outlook.


virgilcaine's picture

Someone sabotage that fiber optic cable.

knukles's picture

Just one teenie tiny electro-magnetic-fart, one nice solar flare, coronal ejecta and its all fucking over.
Or even another machine distributing false information, at the expense of all other machines, without a human overlord.
The drones shall kill upon their own recognizance, the genetic engineering turn upon Nature and Nature's God.
And all shall have been the folly of men, themselves.
No victimization permitted.

There will be an intersection, a solution set of Murphy's Law, the Fourth Turning and the Book of Revelations.  The calendars shall not end, but so shall men's countings.

BKbroiler's picture

I'd greatly appreciate the number to your dealer.

spentCartridge's picture

Grow your own.


My Cheebus 'son of God' mind warping bud will be ready & cured for Christmas :)


All you need is sunshine, soil & rain ...

GMadScientist's picture

"I can see my house from here."

Ineverslice's picture


what a Christmas gift that would be...

Please, that would be greater than...throwing Old Man Potter down 10 flights of stairs.


Urban Redneck's picture

They are actually EMP proof, so the cockroaches and the veins of Skynet will survive a nuclear apocalypse.

CPL's picture

Urban Redneck is right, for those that have ever been in a data center those big monkey cages around them are Faraday cages.  They block radio signals going out and going in.  EMP included.


Doesn't stop the other 99.99956% of the infrastructure going up in smoke though.  Because layer 2 is worthless without the other 6 layers in the OSI stack to manage the whole package.  Like saying you have 40k tires and you put them on a Yugo that won't turn over.

cbxer55's picture

I read the entire EMP Commission Report. According to that report, faraday cages are useless against EMP. EMP travels through the wires into the system. If you are talking about a nuclear blast within the atmosphere, your probably correct. But a proper EMP detonation, in space, faraday cages are useless according to the report. They did all kinds of testing to determine that point.

It's a long read btw. There is alot of reference to faraday cages, most of it negative. They say our financial system is fully exposed to a dedicated EMP strike.

Read it and weep. ;-(

Page 45 first paragraph is quoted below.. So whether HFT survives is a moot point anyhow. There won't be anybody left for them to steal from. Chapter 4, starting on page 83, deals with the Financial System, and is an interesting if not scary read.

"It is not possible to precisely predict the time to restore even minimal electrical service 

due to an EMP eventuality given the number of unknowns and the vast size and complexity of the system with its consequent fragility and resiliency. Expert judgment and 

rational extrapolation of models and predictive tools suggest that restoration to even a 

diminished but workable state of electrical service could well take many weeks, with 

some probability of it taking months and perhaps more than a year at some or many locations; at that point, society as we know it  couldn’t exist within large regions of the 

Nation. The larger the affected area and the stronger the field strength from the attack 

(corollary to extent of damage or disruption), the longer will be the time to recover. 

Restoration to current standards of electric power cost and reliability would almost 

certainly take years with severe impact on the economy and all that it entails."

Urban Redneck's picture

EMP travels through COPPER wires, not FIBER OPTIC wires (which only transmit light).  A data center isn't actually hardened unless it has gas tube breakers added to the external copper power lines.  The engineering requirements have been around for decades, but they are cost prohibitive specs to build to unless you have tons of other peoples money at your disposal.

malikai's picture

All for naught. Even if a datacenter is hardened, and I've been in quite a few hardened DC's, it doesn't do you much good when the power itself is out, the genny is burned out (most are on ground level, in the basement, or on the roof), and even if your genny still works, you can't get fuel for it? How are those fuel trucks going to deliver your fuel when their electronics are fried too? Also, how are the refineries going to refine your fuel when their electronics are also fried? And what about the tankers bringing crude? How will they get to port when they too have no power?

Logistics, bitchez!

Urban Redneck's picture

I've been on the outside of the digital money leviathan about a decade, on 9/11 our redundancies worked fine (other being short-staffed due to facilities being taken offline) and our biggest problem was loss of connectivity to other institutions that didn't have decently thought out redundancies in place.  But I don't think the design parameters for SkyNet have fundamentally changed (beyond nice-to-have is now must-have), so it doesn't need to function if and while the muppets are munching on each other, it just needs to be able to be powered back up after a big reset.

CPL's picture

Partner channel connectivity is always a concern.


You guys want to get together and sell IT Hambones of DRP to government open wallets?   We all open an LLC, and put each other on each other payroll, then bid on the unending flow of contract junkets and deliver to the client the DRP solution.  Which would be a pair of scissors and some rope to cut the main trunk if it gets bad enough and the rope is there for the client to hang themselves with because depending on gadgets is a dumb idea.

Urban Redneck's picture

The US government and its subsidiaries are too corrupt for me to do business with. I'll stick with the Banana Republics, the prime & multi-lateral banks, and EM SMEs. If you set up an LLC and don't mind multi-lateral export guarantees, let me know, there are bunch of other western SMEs whose products I also arrange deals for. My optimum transaction is the three-fer: where we get paid for finding financing a for a project, and again when that project uses products we make or sell, and a third time: the gift-that-keeps-on-giving of carried interest.

CPL's picture



Scavenging trends are showing a disturbing amount of theft from them.  A scavengers dream, all that copper, fuel, steel, gold, silver and platnium.  The older generators are worth more in parts than the generators second hand price is my understanding.


How often do they get run and tested?  Maybe twice a year.  For the DnD sites the "testing" is a 19 year old private with a picture of the generator with an asset tag next to the list.  To which the check mark goes in the box and a reassuring "Yup, it's still there".  Even though the person reviewing the asset information wouldn't know what a functioning generator looks like or care enough to make the leap to learn about it.


A Scrapyard scavenger does though.  Like locusts they can pick over infrastructure much faster than it can be repaired to only match the obscene costs of after market repair.  Plus insurance refuses to cover AC/Heater/Genny costs anymore because they can't afford the claims

fireburn999's picture

Electromagnetic Pulse travels through copper wires but not Fiber Optic wires because they themselves transmit light which is a photon which is an electromagnetic wave? Please... The tinfoil hat may allow some of those electromagnetic waves to bounce off you... :)

Edit: It is true that a fiber optic cable will not accept interference from EMP but your explanation is unscientific and horrifyingly awful. Light travelling through a fiber optic needs to be guided through the waveguide at an appropriate angle depending on the material of the wire. The incoming pulse will be out of phase with the propagating optic wave.

CPL's picture

It's been my theory that nobody has actually tested the requirement of a Faraday cage, but the theory was sound enough, use the cage to ground the radio signal and make it a mess.  

Disaster Recovery Planning right in line for the "Dunno when it'll be back on".  DRP, how to save humanity by committee.  Problem with committee's is the solution is only as smart as the dumbest person in the room.



malikai's picture

Damn I hated being on those crap committes. You can't fix stupid, and you can't get shit done when you fill a room up with stupid and two or three people who know what's going on.

Exxon likes to video their committes. Imagine being the reviewer of one of those..

cbxer55's picture

Found this as well. A faraday cage will work as long as there are no electrical wires penetrating the shield. I believe all of these HFTs have lots of wiring going into the "cage", thereby negating the value of the thing.

"Copper or aluminium foil can help you insulate a whole room from EMP as well. Just paper the wall, ceiling and floor with metal foil. Ideally the floor is then covered with a false floor of wood or with heavy carpeting to insulate everything and everyone inside from the shield (and EMP). The only catch to this is that care must be taken NOT to allow electrical wiring connections to pierce the foil shield (i.e., no AC powered equipment or radio antennas can come into the room from outside). Care must also be taken that the door is covered with foil AND electrically connected to the shield with a wire and screws or some similar set up."


Urban Redneck's picture

Hence the "tinfoil hat" brigade. Certain obstacles are most efficiently & effectively overcome if the structure is purpose built, as opposed to retrofitting existing structures. I recently built a building, in the US where lightning (and other electrical surges) was a major concern. There were over 30 underground service entrance penetrations (pipes) through a heavily reinforced concrete wall in an area 10ft long and 3ft tall, and each of them required significant parts and labor expenses over traditional construction methods. Had EMP been a concern, the best approach would have been to add a signal attenuating screen/mesh before the concrete was poured, but this can also be done later for only incrementally more cost than if added before the concrete, whereas reconstructing the service entrances would add significant cost. But properly identifying and prioritizing concerns is critical. A retail consumer can go to Lowes and get a single door and lock for a couple hundred dollars. A commercial consumer can also go to Lowes and pick up an entry-level fire-rated door assembly for about a thousand dollars. Industrial and military consumers have to go elsewhere, and if there are even basic signal attenuation or blast resistance specifications to be met- then a door assembly will probably start in the 3000-6000 range. The labor cost escalations due to complexity are similar to the materials escalations. Extend the comp from a single door to all the doors, windows, walls, fixtures and other building components and it becomes apparent why so little of the existing infrastructure is not designed to overcome or eliminate so many known threats. The cost-effective solution adopted by institutional consumers tends to be to risk reduction as opposed to elimination.  

Aluminum foil may be the favored risk reduction approach of the tinfoil hat brigade, but I've never tried it. Signal attenuation range for an EMP is different than for cell phones, but I've never been able to get cell phone signal in a properly hardened facility (that didn't also have internal cellular repeaters). So that might be cheap litmus test. However, a tinfoil hat would definitely be the cheapest option, because the opportunity cost is giving away, or not having in the first place, a HUGE stack of shiny PMs (unless you have an HFT bot skimming millions of pennies in front of the steam roller of a banking collapse on the horizon).

debtor of last resort's picture

The puppetmaster is still the same. Some things never change.

Joystickquants bitchez.

Boilermaker's picture

Ah, come on now....What's the worst that could happen?

Boilermaker's picture

Ah, come on now....What's the worst that could happen?

Boilermaker's picture

Ah, come on now....What's the worst that could happen?

francis_sawyer's picture

FYI ~ I (+1'ed) the first comment & junked the next two... Out of respect for the fat finger...

duncecap rack's picture

I kind of like the repeats. It puts in my minds eye a cascade of selling brought on by an errant algo. Given the comment I was wondering if it had been done on purpose.

old naughty's picture

"...wondering it had been done on purpose." Yes.

He is showing us he's not a machine, imperfect.

But wait, he might still be...deliberately fool us.

Vendetta's picture

the machines do what they are programmed perfectly.  Its those who tell the machines what to do that are always imperfect.

RockyRacoon's picture

The worst?  Just imagine what you did a bazillion times over -- with somebody's money.