October 05, 2009

Obsessed with high-speed trading and capturing fleeting price discrepancies between financial instruments, high-frequency traders are pushing the envelope when it comes to low-latency technology. In the race to be first, firms are colocating their strategies in data centers nearer to trading venues and tapping complex event processing to speed executions.

Behaving more like technology firms than trading shops, high-frequency firms first are building their own proprietary models and algorithms, and back-testing them against historical tick data feeds before unleashing them on the real-time market feeds. "One of the fundamentals is an historical tick database -- very large data arrays of available ticks from exchanges," says Dave Dugan, COO at Buttonwood Trading Group, a proprietary trading firm in Chicago that is building high-frequency trading strategies for listed futures and options on futures.

According to Dugan, Buttonwood has been back-testing its strategies against historical ticks from the Chicago Mercantile Exchange. "That was one of the first projects we put together," he says. To speed the launch of its algorithms across multiple markets, the global futures trading firm partnered with Frankfurt-based RTS Realtime Systems Group in February of this year and is using RTS's RTD Tango platform to create, test and deploy the trading strategies. "You're driving a Ferrari," Dugan notes. "What you eke out of these platforms largely depends on your skill and how you drive it."

To eke out even more speed, many of the high-frequency trading firms are moving their black-box strategies into colocation facilities -- data centers that are closer to the exchanges' and ECNs' matching engines. "With automated trading, the black-box traders develop strategies and put them into a black box, and they host it in data centers operated by market centers such as Direct Edge, Nasdaq or Arca," explains Sang Lee, managing partner at Aite Group. "A key element of what they're going to do is get as close as possible to the venue. Firms are willing to pay a premium to get that slot."

When Atlanta-based Hyde Park Global started developing proprietary algorithms four years ago, 80 milliseconds was considered low latency, recalls Adam Afshar, president of the proprietary trading firm, which builds adaptive models for statistical arbitrage and other strategies. "Now the objective is to execute trades below 1 millisecond, and many conversations are in the microseconds," he relates.

To shave off a few milliseconds of latency, the firm is in the process of colocating its servers in New York. "We can colocate our computers in New York for a very reasonable fee," says Afshar. "We don't pay for their cooling or the electricity -- just the space on a rack." He adds, "The point is that colocating cannot only reduce your latency, but also your electrical costs and cooling headaches."

According to Afshar, "By colocating in New York, we are able to take 21 milliseconds off our trades. In the past 21 milliseconds was a trivial matter. Now it's a pivotal matter."

Meeting the Colocation Demand

To capture liquidity from these high-volume trading shops, exchanges and other market centers have opened new data centers or expanded existing ones to offer colocation services. What's more, an entire industry of colocation specialists has sprung up to serve the needs of low-latency trading firms. Many of these players -- including British Telecom, Equinix, Savvis, 7Ticks, and Switch and Data -- have opened up data centers in the major financial markets around the world to accommodate high-frequency trading firms.

"From a geography standpoint, if you're trading [U.S.] equities, you're looking at the area outside the Lincoln Tunnel [in New Jersey], where you have BATS in Weehawken and Direct Edge [Jersey City] sitting within 10 miles of each other," notes John Panzica, VP of Switch and Data's Financial Services Practice, which opened a data center this past October in North Bergen, N.J. The new data center is situated midway between the Weehawken/Jersey City corridor, Nasdaq's data center to the south in Carteret, N.J., and the New York Stock Exchange's planned data center 20 miles to the north.