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ERIC SCOTT HUNSADER, a self-taught programmer who became an expert on market data, argues that rogue traders using high-speed computers deliberately slow the stock market's consolidated tape every trading day, to create fleeting price mismatches among the dozen exchanges handling NYSE-listed shares and to profit from the momentary differences.
Hunsader has given federal regulators an intriguing analysis that suggests that such market manipulation preceded the May 6 Flash Crash and contributed to the violence of the selloff that saw the Dow Jones Industrial Average fall more than 700 points in about 15 minutes, its worse one-day plunge ever. The DJIA bounced up 360 points five minutes later. Some retail investors who had come back to the market after a hiatus of two years were frightened away again.
Hunsader is founder and president of Nanex, a quote-feed provider. "We consolidate all trade quotes from the equities, options, futures, futures options—anything that trades on U.S. markets," he says. He normalizes the data and compresses it 20-to-1 so that it can be sent over the Internet, "which is a thing we do that nobody else does." Customers need only a regular high-speed Internet connection to receive it. High-frequency traders can execute thousands of stock orders each second, via advanced computers using decision-making algorithms. The traders pay exchanges hundreds of thousands of dollars a month for direct feeds to their trading floors and to their pricing data. The data allow them to see information headed for the Consolidated Quote System in advance. The CQS is the "tape" that the stock-buying public sees. The regulators believed that the time advantage provided by the direct feed versus the CQS was just a millisecond or two. But Hunsader asserts that traders are delaying the tapes by hundreds of milliseconds during short intervals.
HOW DO THEY DO IT? HE SAYS that they send quotes for a Big Board stock or combination of stocks to an exchange at the rate of 20,000 quotes-per-second versus a usual flow rate of about 10,000-per-second. The higher or longer the message traffic stays above 20,000, the slower the tape. This seems right out of the movie The Sting. If you have advanced knowledge of the market's direction and more time to use that knowledge, you make more money. You can short a stock before the public knows it's headed down or scarf up shares that are headed higher before individual investors can react.
Exchanges have tried to duplicate Hunsader's findings with their own data for May 6 and say that they have been unsuccessful. They see no corresponding slowdown in the tape at 20,000 trades per second. The tape slows on any heavy trading day. Rather than manipulation, they contend that the slowing might simply indicate insufficient capacity to handle existing customer volume. In any event, they hadn't a clue about any tape slowdowns until Hunsader raised the issue. It lagged behind direct feeds on May 6 by over 20 seconds.
Hunsader says his data show that on April 28, similar high-speed activity caused an ultra-mini flash crash in stocks like Procter & Gamble and Wal-Mart, which fell 50 cents and then fully recovered in just two seconds—more than enough time for a high-frequency trader to short the stocks, buy in at the low and then sell when they again traded with a normal bid-ask spread of a cent. "It was eerily similar to May 6," he asserts, adding that the exchanges could write software to thwart such manipulation. "It's programming 101," he declares.
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