Nanex Chart of Equity Trading after Chicago PMI Data on Feb. 28, 2013. The nemesis of Wall Street's high-frequency traders operates out of an apartment-sized office above the Bliss Salon -- manicure/pedicure $45 -- on Elm Street in the Chicago suburb of Winnetka.
Staring at four computer monitors,Eric Scott Hunsader, the founder of market-data provider Nanex LLC, looks for hints of illicit trading hidden in psychedelic images of triangles dancing with dots that represent quotes to buy and sell U.S. stocks broken down by the millisecond.
Charts of trading produced by Hunsader's eight-person firm have captivated everyone from regulators to art gallery owners. One stunt involved a computerized piano piece mimicking quotes for an exchange-traded fund. He infuriates some traders, who say Nanex draws unwarranted conclusions and spreads conspiracy theories.
To Hunsader, the images created from market feeds are evidence of high-frequency trading firms exploiting market rules to turn a profit in a lawless environment. Though others in the industry see his reports and charts as propaganda, Nanex's interpretations are helping to drive the public debate about the fundamental fairness of the modern stock market.
"You ever see 'Lord of the Flies' or read that book?" he said, using the William Golding novel about boys stranded on an uninhabited island as a metaphor for the stock market. "When you don't have a parent around, things fall apart."
'Ticker Plant'As the 51-year-old Hunsader sees it, that's especially true for a market capable of spewing out quotes to buy and sell stocks at rates as fast as 2 million per second, compared with about 1,000 in the 1990s. The options market can produce quotes at a rate of more than 10 million per second, according to Nanex, whose business is to process the data and distribute it to users in what's known as a "ticker plant."
Hunsader's firm detected what it said was suspicious trading before the government's jobs report on Oct. 22. On Oct. 16, Nanex i! dentified a buy order worth more than $400 million shortly before the open of European exchanges. The orders for E-mini S&P 500 futures were canceled "just before selling began in earnest," Nanex said.
Nanex labeled the report "Panthers on the Loose?," arguing the trades resembled a case that caused the Commodity Futures Trading Commission to order Panther Energy Trading LLC to pay $2.8 million in fines and forfeited trading profits. The firm was accused of "spoofing," or using an algorithm to illegally place and quickly cancel bids and offers in futures contracts in order to create the false impression of demand.
David, Goliath"It shouldn't take the regulator more than an hour to figure out who did it, and a day to find out the intent," Nanex wrote in the Oct. 16 report. "We'll wait."
Hunsader's firm portrays itself as David fighting industry Goliaths, the deep-pocketed HFT firms that dominate U.S. stock trading. That industry has started fighting back -- accusing Hunsader of drawing the wrong conclusions about what his charts show.
Making a joke about Nanex was the first thing Chris Concannon, a partner at proprietary trading firm Virtu Financial LLC in New York and former Securities and Exchange Commission attorney, did when he stepped to the microphone at an industry event last month.
"I'm required to announce our sponsor of this segment, which is Nanex," Concannon said to laughter at the Security Traders Association's Market Structure Conference in Washington. Nanex's tag-line, he said, is "making markets better with inaccurate information."
Advance WordVirtu and Nanex had traded insults since Hunsader published a report on Sept. 20, two days after the Federal Reserve surprised markets by not reducing the $85 billion of monthly bond purchases it makes in its quantitative easing program.
Titled "Einstein and The Great Fed Robbery," the report cited market data that it said showed some trading ! firm or f! irms got advance word about the Fed's decision and then used the milliseconds-long head start to place bets totaling more than $1 billion. A millisecond is one-thousandth of a second, or three places to the right of the decimal point -- one farther out than how Olympic track and swim times are posted. Following the report, the central bank began a review and ultimately tightened the way it releases its statements.
Virtu's report said Nanex's study was "severely flawed" because of the type of data feed it relied on. Hunsader replied that Virtu needs to buy a "new calculator" and that if you read the report closely enough it corroborates his own theory that the information left Washington early.
Concannon didn't respond to five phone calls and e-mails seeking comment on Nanex's statements.
'Disprove Mine'Hunsader, dressed in jeans, a white short-sleeved shirt and running shoes in the Winnetka office, points at the approximately 3,000 pieces of trading research he's released, claiming he has never stood down from a finding. How do you publish that many reports, he said, "and not ever have to retract them?"
"If you can't prove your point, then disprove mine," he said. "But don't go around saying we think you're making leaps without backing it up."
A high-frequency tweeter with more than 11,000 followers, Hunsader conducts his crusade on the Internet and with interviews with journalists, documentary film-makers and others looking for someone to explain today's computerized market.
Many of his more than 11,500 Twitter posts contain links to his charts highlighting unusual patterns in stock quotes and often blaming computer algorithms being used by HFT firms. "Obscene manipulation in $AAPL stock. Where's @SEC_News on this & 1000's of other examples?" he posted on Oct. 5, referencing the symbol for Apple Inc. and a Twitter feed run by the SEC.
Market PoliceRegulation NMS, the set of rules that ope! ned stock! trading to greater competition six years ago, has helped fragment the almost $22 trillion U.S. market to the point where orders to buy and sell bounce between 13 exchanges and more than 40 alternative platforms. Bloomberg LP, parent of Bloomberg News, operates an equities venue called Tradebook and is a provider of market data and analytics.
In Hunsader's view, the computerized firms that benefit from the fragmentation by profiting off fleeting price discrepancies between markets are not being policed enough.
The results, according to Hunsader, included higher data-processing fees and unexplained lurches in the prices of individual stocks that cause investors anxiety. There is also the potential for more outright disasters, he said, like the May 2010 "flash crash" when the Dow Jones Industrial Average extended a drop to almost 1,000 points within minutes.
'Truthers'Nanex regularly misunderstands what it sees in market data and is fueling misconceptions that damage investor confidence, according to Manoj Narang, founder and chief executive officer of HFT firm Tradeworx Inc. in Red Bank, New Jersey. He compared Nanex to the "truthers" who doubt the official explanation of the Sept. 11 terrorist attacks.
There are usually benign explanations for what look to Nanex like attempts to manipulate prices through what it calls "quote stuffing," he said. For example, he said, bursts of quotes could be trading algorithms reacting when the difference between the best bid to buy and the best offer to sell grows to more than a penny. The programs automatically cancel the orders after exchanges modify them to avoid markets where bids equal offers, according to Narang, resulting in "inadvertent repetitive behavior" by algorithms.
"The conclusions that they form generally have a paranoid or conspiracist sort of bent to them," said Narang. "Stirring the pot like that and dabbling in all of these conspiracy theories, and having those things get a seriou! s airing,! undermines investor confidence. And for no real reason."
Simplifying a market that is spread across so many trading venues is easier said than done, said Larry Tabb, chief executive officer of market-research firm Tabb Group LLC.
'Too Complex'"The markets are certainly too complex," Tabb said in an e-mail. "The problem is how do you simplify it? Are there too many exchanges? Too many dark pools? Too many algorithms? To simplify the structure the SEC needs to make some very unpopular decisions that go against 15 years of market structure history, which actually benefits many investors. They are in a difficult spot."
The Nanex founder said one place for the SEC to start is to use its new Market Information Data Analytics System, known as Midas and built by Tradeworx, to explore what he considers one of the top issues with modern markets. Direct data streams from the exchanges, which HFT firms such as Virtu receive, are delivering more timely information than the consolidated feeds that are sent to the rest of the market and were meant to level the playing field, Hunsader said. Hunsader's firm uses the consolidated feeds.
Boutiques, NanexSEC spokesman John Nester declined to comment on Nanex's assertions. Also declining to comment were Eric Ryan, a New York Stock Exchange spokesman; Rob Madden of Nasdaq OMX Group Inc.; and Randy Williams of Bats Global Markets Inc., which is combining with Direct Edge Holdings LLC.
Nanex's office in a village of upscale cafes and boutiques consists of a room dominated by Hunsader's wall of monitors, another filled with stacks of servers, a common area with a mini-fridge stocked with soda -- and not much else.
Answering the front door is Nate Rock, a 34-year-old software engineer with a bushy beard and a penchant for dropping references to Dungeons and Dragons into conversation. He became interested in Hunsader's work after trying to invest some spare money made at a previous job at Infinite Campus! Inc., wh! ich makes software for educators and students.
Barefoot 'Dogbert'Barefoot, wearing camouflage shorts and a black T-shirt that says "meh," Rock uses the professional title "Dogbert" in reference to the canine sidekick in the "Dilbert" comic strip. He read about Hunsader's work on the blog Zero Hedge and got a job after exchanging e-mails with Nanex programmer Jeff Donovan during a vacation day spent drinking with a buddy and watching Facebook Inc.'s initial public offering in May 2012.
"My original schooling was in sciences and I saw the work that Eric was doing and I was like, he's a scientist," Rock said. "It's very detailed down to the millisecond. And I hadn't seen that anywhere."
Among those who have come here to pick Hunsader's brain is Jim Angel, a finance professor at Georgetown University who studies market-structure issues. He said Hunsader's research is a valuable service even if he doesn't always agree with the conclusions, since there's not enough information available to prove what is happening in the charts.
'Some Blemishes'"I don't think his analysis is always correct," Angel said. "He doesn't know who's trading, who's putting in the various quotes. But there are imperfections in our market operations. And even though on average our markets are a whole lot better than they were 10 or 20 years ago, the reality is, hey, there's still some blemishes around the edges that can and should be addressed. And he draws attention to them."
Hunsader has delivered his critique of the markets to everyone from officials at the Federal Reserve Bank of Chicago to members of Britain's government at 10 Downing Street in London.
"He's kind of the mosquito in the room that people pay attention to," said Van Hutcherson, trader at JonesTrading Institutional Services LLC in Oak Brook, Illinois. "He shines a light on some pretty important situations that I think go unnoticed because the ma! jority of! folks, unless you're super sophisticated, don't have the technology."
YouTubeTo illustrate computerized trading to the general public, Nanex has turned trading data into animated videos, with triangles and dots representing tens of thousands of orders dashing between exchanges. One video he posted on YouTube showed a 50-millisecond period in which quotes for Nokia Oyj dashed around the market at a rate of 22,000 per second. The video, published on Oct. 9, has been viewed more than 6,400 times.
He programmed a computer to play piano notes corresponding to different bids and offers for a popular exchange-traded fund, resulting in a manic staccato composition even when slowed down. It was meant to highlight what Hunsader says is the absurdity of modern computerized trading.
"Everybody who's gone this route has had to be a little bit theatrical and Wall Street doesn't like it," said Haim Bodek, founder of Decimus Capital Markets LLC, which develops computer programs to help institutions better trade with HFT firms and avoid "predatory" behavior.
'Deep Flaws'"The irony here is that he really is addressing these deep flaws," said Bodek, who previously founded Trading Machines LLC, a high-frequency options firm, and headed electronic volatility trading at UBS AG.
One of Nanex's charts was featured in artist Trevor Paglen's book "The Last Pictures," an archival disc of which was launched into space aboard a satellite a year ago as part of a project to leave "artifacts of human civilization" that will continue to orbit Earth long after humans are gone, according to the project's website.
Hunsader started in the era of floppy disks, spending "my total life savings," he said, to buy a personal computer in 1984, a machine he still keeps under his desk. He stored each day's trading data from the Chicago Mercantile Exchange and sold the information on a computer bulletin board, the precursor of the Internet.
Cadill! ac, Compa! qIn 1987 he got a job offer from Tom Joseph, founder of Trading Techniques Inc., who developed technical-analysis charts to study movements of asset prices. While most traders were still shouting or making hand signals on exchange floors or hunched over early desktop PCs, Hunsader and Joseph were able to check stock charts as they rode around in Joseph's Cadillac with a Compaq computer hooked up to a car phone.
Trading Techniques was bought by CQG, a trading software maker, and Hunsader went to work for that firm. He read a book on Java code, then wrote an application that allowed users to get streaming intraday stock charts on the newly developing Internet. The founder of the website Quote.com was interested in the application and hired Hunsader.
"We put it up on their site and we went from zero to 10,000 paying subscribers in about 18 months," he recalls. "About $100 a month these guys are paying for this little thing on the net. They had to hire temps in on the weekends to freaking process all the credit cards."
Number FiveThe Internet portal Lycos Inc. bought Quote.com in 1999 and Hunsader left. The next year he focused on writing the software for his own venture, into which he poured thousands of hours of development time.
The result was the ticker plant Nanex, which receives quotes from consolidated market feeds and distributes the data to users through software that allows them to analyze, chart it and write their own trading programs to complement its software.
The flash crash inspired Hunsader to look more closely at the data he was distributing. He set out to figure out what was going on with Donovan, a southern California surfer and ticker-plant programmer who also develops three-dimensional graphics software.
"We saw the SEC was kind of dragging," Hunsader recalls, "I said to him, 'you know what, we've got the data. We could do this. Let's see what we could do, let's just have fun.'"
As the pair drille! d through! the quotes, unexpected patterns emerged in charts for stock orders. They called them crop circles, a reference to the mysterious patterns sometimes reported in grain fields, and published them as research on the firm's website.
"That was a blessing and a curse," Hunsader said. "It was a blessing because it caught the eye of Main Street, and it got us into the Atlantic which got us into the New York Times. But the curse was that the Wall Street glitterati, or elites, used that to paint these as conspiracy."
