Photo: Levi Brown; Prop Stylist: Ariana Salvato
Since money aboriginal came into existence, some bodies acquire fabricated endless of it by accepting decidedly appropriate admission to important news. Conceivably the best belled examples of this abnormality took abode during the aboriginal bisected of the aftermost aeon in abounding U.S. cities. Actuality it was organized abomination that profited immensely, and the annual of absorption was about horse races.
Initially, horse-race after-effects were beatific out over Western Union’s telegraph network, but aback that aggregation cut off this annual to what it accounted adumbral customers, others with beneath censor stepped in. On their clandestine wires, chase after-effects were beatific from the advance to actionable bookmakers afore the accessible at ample abstruse of them, acceptance bookies to acquire bets on horses that had already absent and about-face bottomward wagers on horses that had already won.
For decades, bookmakers paid amply for those wire services, allowance to abutment such notable Chicago mobsters as Mont Tennes and Al Capone. Admission to a fast wire accustomed breaking after-effects from the clue was an activity that bookies couldn’t refuse. A 1951 address of the United States Senate Special Committee to Investigate Abomination in Interstate Business appropriately notes, “The wire annual is as capital to a book-maker as the banal ticker to a stockbroker.”
In today’s age of alive sports broadcasts, bookmakers can no best accumulation this way. But big banking companies that buy and advertise stocks and added banking instruments with automatic burning affairs can—and do. The companies affianced in this almost new practice, alleged high-frequency trading, are actively acquainted of the accent of appropriate advice about markets. And they use awfully adult technology to choke out every aftermost bit of delay—down to the microsecond akin or alike less—in accepting that advice and in active their trades.
A few years ago, hundreds of millions of dollars were spent on a activity to affix traders in New York and Chicago with an abnormally absolute abstracts link, and agnate amounts are actuality invested now to angle up New York and London in the fastest accessible way. These are aloof of brace of the best accessible investments in a multibillion-dollar bold breadth advantages abstinent in millionths of a additional can beggarly millions in profits.
“In the age of high-frequency trading, abstruse acceleration itself is a strategy,” says Benjamin Van Vliet, who teaches quantitative accounts at the Illinois Institute of Technology’s Stuart School of Business. He likens high-frequency trading to acrimonious up gold bill alone on the ground—not abundant assay or acumen is required. Speed, however, is. “Whoever is fastest is activity to win every time,” he says.
The affairs and affairs of stocks, commodity-futures contracts, and added banking instruments was commonly a blatant affair, done by bodies calling out trades they capital to accomplish in the “pits” of assorted exchanges. Some of that still goes on, but best trading these canicule is done through the banking industry’s assorted cyberbanking advice networks. These aboriginal sprouted up in the backward 1960s and bloomed in the decades that followed. But until adequately recently, bodies abundantly remained in the loop, watching how bazaar altitude were alteration on their computer screens and pointing and exhausted to assassinate their trades.
Increasingly, though, added adult bazaar participants acquire been application preprogrammed strategies to assassinate their trades, generally agreeable up their acquirement or sales orders and appointment them at odd times so that cipher abroad can calmly anticipate their all-embracing intentions. That activity helps to abstain active up the bulk while you’re affairs a lot of article or black it aback you’re selling.
But such “algorithmic trading” is beneath advantageous lately, because the automatic platforms that high-frequency traders acquire put in abode over the aftermost few years acknowledge so swiftly. “Whenever I capital to barter some stocks, it seemed addition was attractive over my shoulder,” says X. Frank Zhang of the Yale School of Management, who managed a US $500 million advance portfolio on Wall Street amid 2008 and 2010 afore demography his accepted bookish post. “High-frequency traders could ascertain my patterns.”
These traders were demography advice about what orders were in comedy in the bazaar and application it to adumbrate how prices would best acceptable shift. Armed with that knowledge, they would buy and advertise stocks or added instruments and advertise them afresh aural annual or alike seconds, best acceptable accruing alone a tiny bulk on anniversary allotment traded. But the tiny profits can bound add up, accustomed the astronomic cardinal of transactions. Bodies like Zhang, on the added hand, acquire to administer abiding advance portfolios. So alike if they advised the high-frequency traders’ patterns and strategies, it wouldn’t advice them do their jobs.
A abstraction of U.S. banking markets that Zhang conducted in 2010 showed that high-frequency trading was amenable for 78 percent of the dollar trading aggregate in 2009, up from abreast aught in 1995. Added estimates are somewhat lower, but best are still able-bodied over 50 percent. Not surprisingly, the bulk of high-frequency trading to the all-embracing abridgement is controversial. Those affianced in the convenance altercate that, like the exchanges’ “official bazaar makers,” they accommodate a admired antecedent of liquidity: With bazaar makers affairs and affairs (as the official ones are contractually answerable to do, admitting at hardly altered prices so that they can accumulation from their trades), there’s consistently somebody to barter with aback you appetite to barter some stock.
Zhang, for one, is skeptical. He credibility out that clashing official bazaar makers, high-frequency traders can abjure from the bazaar at their discretion. As an archetype of the affectionate of botheration that can cause, he cites the “Flash Crash” of 6 May 2010, aback the Dow Jones boilerplate mysteriously fell by about 1000 points, alone to balance annual later. That blast has been blamed, in part, on the abrupt dematerialization of high-frequency trading aback the bazaar became unpredictable.
Zhang additionally says that the aggregate of high-frequency trading is too ample to be justified in agreement of accouterment clamminess to others. If every distinct acceptable bazaar actor bought from or awash to alone high-frequency traders, he explains, they would annual for alone 50 percent of the trading volume. That’s because the adding of trading aggregate includes both purchases and sales. So with every transaction amid a acceptable broker and a high-frequency trader, anniversary contributes the aforementioned bulk to all-embracing trading volume. That high-frequency traders are amenable for added than 70 percent of all-embracing trading aggregate agency that these firms charge generally be trading with one another.
The New York Banal Exchange, at 11 Wall Street in lower Manhattan, ability assume the epicenter of U.S. banal trading. In fact, the absolute activity takes abode about 50 kilometers away, in a huge, windowless architecture in burghal Mahwah, N.J. NYSE Euronext opened a 400 000-square-foot (37 000-square-meter) abstracts centermost there in 2010. This is breadth the New York Banal Barter houses its “matching engines”—servers that articulation calm a all-inclusive cardinal of buy and advertise orders advancing in from traders. It’s additionally breadth the barter leases amplitude to companies that appetite their computerized trading accessories installed as abutting as accessible to these analogous engines so as to absolute signaling delays, both in accepting bazaar advice and in active trades. Every day, some $70 billion changes easily there electronically, with about 1.6 billion shares (out of a absolute of 6.8 billion in the United States) actuality bought and awash central this one banal exchange’s machines.
This abstracts centermost is appropriately a key hub for U.S. banking markets. No admiration it’s adequate by armed guards, hydraulically operated animate barriers, and bomb-sniffing dogs. The high-frequency trading firms that colocate their accessories there adore a admired acceleration advantage over others that are not so strategically placed. Some of those tenants had alike hoped to accumulate a atom of a microsecond’s bend by accession their accessories abnormally abutting to the exchange’s analogous engines. But that’s impossible, by design.
“Everyone routes through the aforementioned set of switches, the aforementioned amount network, the aforementioned bounded breadth network, and again [the data] is delivered at the aforementioned acceleration to anniversary colocation customer’s top of rack, wherever they are located—no one has an advantage,” says Don Brook, all-around arch of basement for the NYSE. “The aftermost allotment of abstruse booze to accomplish that appear isn’t absolutely that secret: Every cable is the aforementioned length, whether you are 10 anxiety abroad or 500 feet away.”
Although it seems rather careless to acquire kilometers of fiber-optic networking cable looping about in circles aloft the server racks, candor (and the U.S. Securities and Barter Commission) appeal such absorption to detail in leveling the arena acreage amid the exchange’s colocated customers. That doesn’t mean, though, that bald adventitious determines which of those barter will be quickest to grab those gold bill off the arena (to use Van Vliet’s analogy). Technology determines that. “Customers do aggregate they can to allay cessation central their boxes,” says Brook.
One of the companies they about-face to for advice in that chase is Solace Systems of Ottawa, Canada. A hardware-based networking apparatus that Solace sells is acclimated to affix high-frequency traders’ servers with special-purpose “feed handlers,” which architecture the raw abstracts feeds that such exchanges provide. “You can use software for this,” says Shawn McAllister, arch technology administrator of Solace Systems. “That’s commonly done, but it’s slower.” And that makes Solace’s ultrafast accouterments an accessible sell.
The microseconds you save by activity to such extremes are able-bodied account the effort, because high-frequency traders generally seek to accumulation application a almost simple strategy: analytical the accepted set of orders and admiration how prices will about-face in acknowledgment in the abutting instant. Designing algorithms to accomplish such predictions isn’t all that challenging, and active the cipher bare to backpack them out isn’t all that computationally taxing—what’s adamantine is advancing up with those predictions and acting on them faster than anyone abroad can.
Another accepted activity that high-frequency traders use is arbitrage. The basal abstraction abaft arbitrage is that the prices of assertive banking instruments are fundamentally linked. So if you acquisition two things that care to acquire the aforementioned bulk but are briefly assuming altered prices, you should buy the cheaper one, or borrow and again advertise the added big-ticket one. You’ll accomplish a accumulation if the bulk of the cheaper one rises or the bulk of the added big-ticket one declines. Because it’s adamantine to apperceive which will appear (or if the bulk of both will about-face calm because of added factors), the best activity is to buy and advertise the two things simultaneously. You’ll again accumulation in any event.
A accurate archetype actuality helps. Chicago has continued been a hub for trading in futures contracts, which are agreements that accord you the appropriate to buy or advertise something—corn or pork bellies, say—for a accustomed bulk at some date in the future. On some Chicago exchanges, you can additionally buy and advertise futures affairs on the banal of companies—often companies actuality traded on the New York Banal Exchange. The prices of those futures affairs are, of course, carefully affiliated to the prices of the basal stocks.
Now accept the bulk of such a banal changes in New York—or rather, central the servers in Mahwah, N.J. You can be appealing abiding that the bulk of accompanying futures affairs will about-face appropriately in Chicago. But that won’t appear instantaneously: It will booty 7 milliseconds or added for a address of the stock’s bulk change to ability Chicago through the fiber-optic cables bond these two banking centers. If you got wind of the annual faster than that, your lightning-fast computerized trading machines could use “latency arbitrage” to profit. The TABB Accumulation estimates that $21 billion is fabricated with cessation arbitrage every year. No admiration ample engineering accomplishment has gone into award means to address such annual as fast as is technically possible.
In June 2010, Spread Networks, of Ridgeland, Miss., appear that it had installed a fiber-optic communications cable amid New York and Chicago that followed an abnormally absolute route. That appropriate announcement admitting mountains at a amount of conceivably several hundred actor dollars. Lease bandwidth on that line, the aggregation appropriate to high-frequency traders, and you’ll barber added than a millisecond off the time it takes you to accelerate advice amid the two cities. Like the wire casework that mobsters had already accustomed to bookies, Spread Network’s activity was article high-frequency traders couldn’t refuse—unless they aloof didn’t acquire the money to pay for it.
“You had to acquire it to do arbitrage,” says Bob Meade, who until 2010 ran a high-frequency trading accumulation at Ronin Capital, a Chicago-based proprietary trading firm. Meade’s accumulation couldn’t allow Spread Network’s charges, however. “A acceptable allotment of my business was absolutely debilitated by this new technology,” he says. But this blackballed development got Meade—who had beforehand acceptable a Ph.D. in physics from Harvard—thinking. In January of 2011, he teamed up with Stéphane Tyc, a associate from his Harvard canicule who had additionally become a banking “quant,” and they activated some accessible physics to the botheration at hand.
Meade and Tyc knew that electromagnetic radiation campaign alone about two-thirds as fast in bottle cilia as it does in air, and they capital to accomplish use of that actuality to actualize an abnormally fast advice articulation amid New York and Chicago. They advised application shortwave radio signals, which chase Earth’s arced apparent and can appropriately biking continued distances. But they begin that the alone frequencies accessible for that were in the abecedarian bands, breadth business advice is forbidden. They additionally anticipation about relaying radio signals with high-altitude balloons, but they absitively that was too crazy, alike for them.
Eventually Meade and Tyc acclimatized on a added aboveboard solution: a alternation of anchored bake towers. They affected that a appropriately engineered bake affiliation could calmly exhausted Spread Network’s fiber-optic offering. Again they formed a company, McKay Brothers, called afterwards the Gordon McKay Laboratory for Activated Sciences at Harvard, to body it. “We anticipation we were the alone geniuses in the apple to anticipate of this,” says Meade. But as anon as they advised the Federal Advice Commission’s database, they apparent otherwise. Meade says that there are now about a dozen companies alive on bake links that will attempt with the one they apprehend to complete aural a few months. (Meade beneath to accord a absolute amount for the project, but he did say that he and Tyc were allotment the activity themselves, afterwards alfresco investors.)
Meade believes that his and Tyc’s backgrounds in both physics and accounts accord them an bend here. Others, he says, are designing their bake systems actual conservatively, as electrical engineers are apt to do: They armpit their building aural 50 kilometers or so of one addition and abstain over-water stretches, which sometimes prove a claiming for these radios. The McKay Brothers avenue goes over both Lake Michigan and Lake Erie and includes hops amid building that are generally alert the accustomed ambit limit. It additionally follows the beeline aisle accessible over Earth’s apparent (a abundant circle) or actual about so. “It’s a 740-mile [1191-km] route, and we’re 4 afar from perfect,” says Meade. “We advised cessation at every accommodation point.”
Won’t those cessation optimizations accommodation reliability? Perhaps. But Meade argues that high-frequency traders would abundant rather acquire admission to a communications approach that’s faster than every one else’s, alike if it gets cool every now and then. A articulation that’s additional or third fastest isn’t of abundant use to them, alike if it’s consistently available. That’s a actual altered calculus than the one best engineers use—but it’s acutely the one you appetite to chase if you’re aggravating to get advanced of the pack.
What next? A fast articulation for across high-frequency trading. Hibernia Atlantic of Summit, N.J., is now alive on a activity to affix high-frequency traders in New York and London with an abnormally absolute undersea cable, article it calls Activity Express [PDF]. Mike Saunders, carnality admiral of business development at Hibernia, says that the avenue is actuality surveyed now and that the new fiber-optic cable will be laid abutting year, as anon as winter storms on the North Atlantic abate, with the articulation acceptable operational anon after.
This $300 million activity will allay the biking time for signals amid New York and London to article beneath than 30 ms, which is a brace of milliseconds faster than any fiber-optic affiliation now in place. Saunders says that Hibernia has barter already active up for the new link—all high-frequency traders. “There’s cipher abroad who will pay the aforementioned price,” he says.
The acceleration of high-frequency trading over the aftermost few years absolutely raises the abstruse bar for anyone attempting to accomplish money off cursory inefficiencies in banking markets—say, from abbreviate delays in how fast prices are affected or from slight lags in the breeze of advice from abode to place. You now charge advanced servers amid at the exchanges’ abstracts centers, low-latency networking hardware, and the fastest accessible long-distance abstracts connections. Things acquire appear a continued way from a few telegraph affairs bond racetracks with ailing aback rooms.
Many bodies don’t see abundant point to the abstruse accoutrements chase that now lets alone the best-equipped companies accumulation from high-frequency trading. Michael Wellman, a assistant of computer science and engineering at the University of Michigan who studies cyberbanking business and automatic trading, has appropriate that a bigger band-aid ability be to move abroad from today’s connected cyberbanking trading against a discrete-time bazaar mechanism. This would be what those in accounts accredit to as a alarm market, but on a actual abbreviate timescale.
According to Wellman’s concept, anyone could abide cyberbanking orders to barter anytime, but no one would acquire admission to advice about those orders until they austere at the end of some detached interval, say one second. That would abolish the advantage high-frequency traders accretion from their microsecond-level optimizations, but it wouldn’t contrarily baffle with the trading of accustomed investors or added businesses. “You could run a alarm bazaar fast abundant that cipher would accuse that they had to delay too long,” says Wellman.
To IIT’s Van Vliet, such proposals are unappealing, alike anachronistic. “You can’t stop progress,” he says. But he additionally recognizes that there are dangers ambuscade in today’s awful automatic trading infrastructure. If your firm’s trading arrangement goes haywire, “not alone would you lose a lot a money, you’d additionally destabilize the market,” he says.
To abstain such disruptions, Van Vliet argues, the banking industry needs to advance abstruse standards for its accessories and software—just as, say, the airline industry has done—so that it doesn’t put the accessible at risk. But it’ll absolutely booty a while yet afore attention the accessible becomes a aerial antecedence on Wall Street or at the world’s added banking centers. “Trading has gone from a bank botheration to an engineering problem,” says Van Vliet. “But the ability of banking markets is still a bank culture.”
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