When the New York Stock Exchange celebrated its Euronext merger at the closing bell on April 4, the trading floor erupted in boos and jeers from many traders who see the merger as yet another threat to their livelihoods. With the spread of electronic trading — it now makes up 60 percent to 70 percent of the daily volume on the NYSE — the manic floor traders look to be headed the way of the exchange's in-house barber (long gone). In the past year, the number of traders on the NYSE has dropped by a quarter.
Firms are turning to electronic trading, in part because a 1-millisecond advantage in trading applications can be worth millions of dollars a year to a major brokerage firm. That is why colocation — in which firms move the systems running their algorithms as close to the exchanges as possible — is so popular.
The need for speed has opened up opportunities for nontraditional competitors in the space, and it has provided established exchanges with new revenue opportunities, such as colocation services for companies that wish to place their servers in direct physical proximity to the exchanges' systems. Electronic trading also has created opportunities for a new class of vendors — execution services firms and systems integrators promising the fastest possible transaction times.
But while electronic trading is putting floor traders out of work and opening opportunities for other ECNs to enter the game, it has reduced overall volatility in the equities markets. Volatility is a product of herd buying or selling, and electronic trading — responding instantaneously to tiny price fluctuations — tends to smooth out such mass behavior, according to observers.
At its most abstract level, the data-latency race represents the spear point of the global movement to eradicate barriers — geographic, technical, psychological and institutional — to fair and transparent markets. "Any fair market is going to select the best price from the buyer or seller who gets their order in there first," says Alistair Brown, founder of Lime Brokerage, one of the new-school broker-dealers, which uses customized Linux servers to trade some 200 million shares a day. "At that point, speed definitely becomes an issue. If everyone has access to the same information, when the market moves, you want to be first. The people who are too slow are going to get left behind."
Value in Milliseconds
On the New Jersey side of the Lincoln Tunnel, in an anonymous three-story building, is one of the financial world's most important data centers. Pushing the doorbell at the unmarked main entrance won't get you inside — it's merely a facade. The servers for five electronic exchanges are located in this data center, along with computers belonging to dozens of trading firms. Run by hosting company Savvis, the Weehawken facility is home to some of the most advanced trading technology anywhere.
Much of Savvis' growth can be traced to the spread of direct market access. In the past, traders used consolidated feeds — market data updates such as those provided by Reuters and Thomson. Distributing those feeds, however, could take up to 500 milliseconds, far too long for today's automated trading. "Now you're seeing a lot of the market data providers and vendors who have direct exchange-feed connectivity," says Varghese Thomas, Savvis' VP of financial markets.
The exchanges themselves also are profiting from the demand for server space in physical proximity to the markets. Even on the fastest networks, it takes 7 milliseconds for data to travel between the New York markets and Chicago-based servers, and 35 milliseconds between the West and East coasts. Many broker-dealers and execution-services firms are paying premiums to place their servers inside the data centers of Nasdaq and the NYSE. About 100 firms now colocate their servers with Nasdaq's, says Brian Hyndman, Nasdaq's SVP of transaction services, at a going rate of about $3,500 per rack per month. Nasdaq has seen 25 percent annual increases in colocation the past two years, according to Hyndman.
Physical colocation eliminates the unavoidable time lags inherent in even the fastest wide area networks. Servers in shared data centers typically are connected via Gigabit Ethernet, with the ultrahigh-speed switching fabric called InfiniBand increasingly used for the same purpose, relates Yaron Haviv, CTO at Voltaire, a supplier of systems that Haviv contends can achieve latencies of less than 1 millionth of a second.
Later this year, Nasdaq will shutter its data center in Trumbull, Conn., and move all operations to one opened last year in New Jersey, with a backup in the mid-Atlantic region, the exchange's Hyndman says. (Trading firms and exchanges are reluctant to disclose the exact locations of their data centers.)
The NYSE will begin reducing its 10 data centers, including those associated with Euronext, to two in the next couple of years, says CTO Steve Rubinow. Colocation, Rubinow says, not only guarantees fast transactions but also predictable ones. "If you've got some trades going through at 10 milliseconds and some at 1 millisecond, that's a problem," he says. "Our customers don't like variance."
One of the biggest colocation customers is Credit Suisse, which handles about 10 percent of all U.S. equity trades daily and which helped pioneer black-box trading systems with exotic algorithms such as Sniper, Guerrilla and Inline. Credit Suisse maintains Sun and Egenera blade servers, some running Linux and some Windows, in all the major U.S. markets, says Guy Cirillo, manager of global sales channels for Credit Suisse's Advanced Execution Services unit, which serves major hedge funds and other buy-side clients. The AES trading engine in Credit Suisse's Manhattan headquarters is replicated in London, Hong Kong and Tokyo.
Guaranteed transaction times for AES clients — from the time the order is received on the Credit Suisse system until it gets an acknowledgement from the exchange, ECN or crossing network — has dropped from 15 milliseconds to 8 milliseconds in the past year, Cirillo says. Total execution time also includes any delays within the exchange or liquidity point itself, a latency variable over which Credit Suisse has no control. "That response time is something the ECNs and the exchanges compete on as well," Cirillo says. "Their latency, their turnaround time and their infrastructure are all part of the electronic game."
Nasdaq is now shifting its Supermontage legacy trading platform — based on Hewlett-Packard, Stratus and Dell servers — over to INET's hyper-rapid system, while the NYSE, of course, has been busy rolling out its hybrid market, based on Archipelago's technology.
Nasdaq's Hyndman says that migrating to INET has allowed Nasdaq to offer the fastest possible transaction times. "We've reduced latency from 10 milliseconds down to 1," he says, referring to the time it takes once an order is placed on Nasdaq's system to acknowledge it electronically.
Traders also are being forced to rely on automated systems more and more, according to a report from TABB Group. And they're using automation "not only to filter the data for them, but increasingly to process that data, interpret it and drive automated trading decisions," according to the report.
Many observers, especially high-frequency traders and new-fashioned broker-dealers such as Lime, see even hybrid systems such as the NYSE's as a stopgap. Soon, they argue, all markets will be completely electronic, and transaction times will be the ultimate arbiter of who gets the best trade at the best price. "Computers are just so much faster and more efficient that there's no point in doing things the old-fashioned way," says Mark Akass, CTO for BT's global financial services unit. "Computers make both the decision process and the execution so much faster that eventually everything will be done electronically."
Out With the Old
High-speed, automated trading over electronic networks eventually will make the traditional exchanges obsolete, or nearly so, predicts David Cummings, CEO and founder of BATS Trading. Founded in June 2005, BATS (Better Automated Trading System) was built from the ground up to take advantage of the new black-box trading schemes and, says Cummings, to compete with Nasdaq, which he regards the way a fighter jet pilot might look at a biplane.
Tough-talking Cummings is perhaps the leading proponent of the theory that the push to reduce data latency represents not just an imperative for Wall Street traders but a new era for Wall Street itself. BATS' trading system, based on multicore HP servers running proprietary software, initially cost all of $2 million, and it averaged response times of less than a millisecond, according to Cummings. That kind of performance earned BATS the top spot from research firm Celent in its latest industry-benchmark rankings of executions speeds, above Nasdaq's trading engine. And, Cummings says, it will get BATS to 1 billion shares traded per month by the end of this year, from just over 300 million in February.
Also offering a new avenue for high-frequency trading is BT Radianz, which resulted from BT's 2005 acquisition of trading-platform provider Radianz. Launched in March, its Ultra Access service provides sub-1 millisecond order-routing services between traders and exchanges in the New York area. That's as fast as you can get, says BT's Akass. "After you get below 1 millisecond, you get to the speed-of-light limitation," he says. "There's not a lot you can do in terms of getting faster."
Therein lies the rub for ultrafast trading: Once you hit physical limits to data-transmission speeds, where do you go from there? "If anybody knows how to get a signal transmitted faster than the speed of light, I'd like to talk with them," says BATS' Cummings.
There are two schools of thought on this issue. One is that traders, exchanges and brokers must shave latency from other parts of the system — in the applications they use, for instance — and that the race will continue.
The other is that latency will cease to be an issue once everyone has access to the same trading infrastructure and that other, older-school elements of the business, such as customer service and market savvy, will once again become the differentiators. "Shortly, we'll be talking micro- versus milliseconds, and at that point speed will probably have less and less relevance," says Lime Brokerage's Brown. "Once you've got half a dozen systems that can all handle that kind of throughput, then you have to distinguish yourself somewhere else."
For now, though, the quest for speed continues. And Wall Street's transformation goes on — at faster and faster rates. "Five years ago we were talking seconds, now we're into the milliseconds," says BATS' Cummings. "Five years from now we'll probably be measuring latency in microseconds."
—With Elena Malykhina
Courtesy of InformationWeek, a CMP Technology property.