As the race toward zero latency reaches dizzying new speeds, firms seeking to eke out that extra microsecond colocate their servers right next to exchange matching engines while continuing to invest millions of dollars in the latest low-latency solutions. But there is one fundamental obstacle that no amount of hardware or money can get around: the speed of light.
And this obstacle is magnified when firms trade securities in geographically separate locations. A trade originating on a server in New York can execute in Tokyo only so quickly when the data must travel half way around the world.
But two scientists have devised a new technique to exploit geography in high-frequency trading and minimize the delays inherent in data transmission, even at the speed of light. "At the highest level, rather than delivering orders for execution at a trading center like New York or London, the idea is to utilize a third location that is intermediate to two geographic cities and use it as a coordinator of trading between the first two," says Alex Wissner-Gross, a research affiliate at the Massachusetts Institute of Technology Media Laboratory.
Together with Cameron Freer, a junior researcher in the department of Mathematics at the University of Hawaii, Wissner-Gross examined pairs of 52 exchanges located around the world. "If you have some stocks traded on the New York Stock Exchange and the London Stock Exchange, but more heavily in New York, you will want to be located between the two cities, but closer to New York," Freer explains. "You want to be where ... you have the largest short-term discrepancy in prices," he says, adding, if pricing is much higher in London, for example, a trader will want to buy at the New York price and sell at the London price.
The technique that Freer and Wissner-Gross devised calculates the optimal location where the trader should "sit" between the financial centers at any one point in time. "But you can also place several nodes between two trading centers, and each can be on the lookout for particular data," Wissner-Gross adds. "Once you have quite a few [intermediary] nodes, you can pick and choose your optimal location."
A number of locations between Asia and the Middle East are optimal intermediates between major financial centers around the world, the scientists found in their research, which was published in the journal Physical Review E. They also identified a hypothetical position about 200 miles off the coast of Newfoundland as optimal for trading between New York and London under specific market conditions. A spot about 20 miles from Norilsk in Siberia, Russia, is the optimal position to trade between London and Tokyo.
But optimal locations for certain pairs of exchanges might be as far-flung as Botswana, Greenland or Mongolia -- or even in the middle of the Pacific or Atlantic Oceans, the scientists admit. "We're identifying locations as a new type of natural resource," says Freer, who suggests that trading locations under the sea or in a remote area are future possibilities. "Depending on different geographic sources of information, there will be a broad trend toward decentralization for some transactions. So over the long term, you can expect new computation in these locations." In the short term, the technique can be useful to pinpoint optimal locations within a single city with multiple data centers, such as New York, Freer points out.
According to Freer and Wissner-Gross, they currently are in talks with several trading firms about licensing their technology. "We're pointing to possibilities all around the world. But in the near term, some places are better wired than others," says Freer. "If a firm is currently trading in multiple markets, it might look at locations that already have the right hardware infrastructure and data centers. Then they can look at other locations and coordinate routing from there. ... Even optimizing routing within a city according this technique can be helpful."