Dario PETROVSKI: High frequency trading: Go faster and faster !

Dario PETROVSKI: High frequency trading: Go faster and faster !

Today, it takes 350 milliseconds to complete 7,000 transactions. This is the time a man takes to blink. A transaction can be done in 5 microseconds or 0.000005 seconds. These numbers show that speed has dramatically changed the way financial transactions operate. This speed could be reached following the various technological evolutions.

Increased competition in the financial sector resulting of financial deregulation in the 2000s and technological evolutions has led to high frequency trading. Financial actors entering this competition are constantly looking for innovations to reduce time differences in their financial transactions. As a result, a new war is emerging among practitioners of high-frequency transactions. The speed of information and transactions becomes the main element of the core of high frequency trading. It is on this aspect that the financial players will base themselves in order to stay alive in this fierce competition.

Optical fiber to reach high speed
The search for speed is not new today. Indeed, markets already had means and tools to facilitate and improve the speed of transactions. Telegraph, phone or roller skates, all means was good to save time on transactions and be the first to achieve the best transaction.

The invention of Thomas Peterffy in 1987 completely revolutionized the markets. The program that buys and sells shares automatically has saved a lot of time on transactions. The number of transactions is growing considerably. But the tool that will completely revolutionize the financial sector and allow the rise of high-frequency trading is fiber optics. To show you the importance of its use for financial transactions, we will take the example of Brad Katsuyama who will be the first to condemn the way that fiber optics is used by high frequency traders. What Brad is going to show is how the stock exchanges are connected to each other by these fibers. He succeeds in appropriating the map of New York by an operator by making him believe that he wants to be his client. The map reveals the different fibers existing in New York and what surprises him is the fibers connecting these stock exchanges.

Stock exchanges in New York unevenly linked by fibers

Brad Katsuyama places his orders from the south of Manhattan. Its establishment is connected to an optical fiber at normal frequency. When his orders pass through the various stock exchanges, certain financial actors can intercept his orders and manipulate them. These actors are attached to optical fibers allowing high frequency. Thus, as soon as Brad will place an order, high frequency traders will be able to intercept the information of these orders before they are executed. So, they will manipulate the markets in order to raise stock prices and resell them to Brad. On the map above, we can see where Brad’s orders (blue tracings) and the path of high frequency traders (red tracings) go. Brad observes, therefore, that his shortcomings in the markets are due to the unequal manner in which he is attached to the New York’s Stock Exchanges.

Telecommunication networks have become a key element in high frequency trading. Every year in November, Chicago gather telecom companies to introduce new technologies and building new fibers to gain speed. This is the “big date” for high frequency traders. Some telecommunications companies are creating high-tech “VIP” networks called dark fiber by professionals. The price to pay for high frequency traders to attach to these high-speed fibers is very high. It varies between $ 3 and $ 5 million a year, knowing that the cost of installing fiber is an average of $ 300 million. The price of attachment to fiber is lower compared to the benefits that high frequency trading can generate.

In the summer of 2010, a telecommunication company directly connected New York to Chicago with a 1200-km private optical fiber. The information then takes 9 milliseconds to cross a third of the United States. This optical fiber has caused some problems for some regions. Sunbury is a city of nearly 10,000 people in the state of Pennsylvania. This region is considered “amish”, that is, it is opposed to technological progress. When Sunbury Mayor David Persing signed the contract for the fiber installation, he mentioned a facility used for telecommunication. The use for high frequency trading is therefore not mentioned in the contract. The passage of this fiber into the city allows Sunbury to raise $ 14,000 a year. Thousands of contracts are signed with municipalities, individuals and businesses with land along the route. Certain confidentiality clauses are included in the contracts in order to maintain the secrecy of use of the fiber.

Even if fiber is a very useful tool for high frequency traders to gain more and more speed in their transactions, there are alternatives to gain a few milliseconds more.

…and the waves to be even faster
Optical fiber is the basic tool for the passage of information in the context of high frequency trading. But a discovery was made by a telecommunication engineer. Stéphane Tyc is a specialist in radio waves. It specifies the fact that the optical fiber must overlap between the different establishments present in its path. He thinks that he can gain milliseconds through the air because the waves can go straight contrary to fiber optics. In 2011, he began working on connecting antennas on the road from New York to Chicago. With this installation, it will enable high-frequency traders to earn 1 millisecond over the fiber by reaching a speed of 8 milliseconds back and forth on this route.

Stéphane Tyc also aims to bring together the two largest stock exchanges in Europe. He wants to install a network of antennas to make the information flow at very high speed between London and Frankfort. Its installation must be as precise as possible because every microsecond gained is important in its work. Antennas must therefore be installed with extreme precision. Moreover, he gains speed by putting his antennas as high as possible. So, he goes looking for height like a church in London where he places his antenna in the steeple or the third tallest building in Chicago on the road from New York to Chicago. The rents to be able to settle in height turn around several tens of thousands of euros per year.

In January 2013, Jump Trading buys an old tower 243 meters high for the price of 5 million euros to install its antennas to pass data between the stock exchanges in Frankfurt and London. This pylon once belonged to the US Army. The Belgian state hoped to reap at least 300,000 euros through the auction of this pylon.

The investment to connect to these antennas is very expensive but it allows to gain more and more speed in the passage of transactions. But there is an even more beneficial technique for high frequency traders. Some companies settle directly inside the stock exchanges. To be able to place their own computers closer to the general server and gain another thousandths of a second, these companies must pay nearly $ 30,000 per month. This method is called colocation. The “roommates” are installed at an equal distance to the nearest millimeter facing the server.

In the sector, there is a real race to speed. High frequency traders are constantly looking for new techniques and ways to earn milliseconds or even microseconds to be the fastest in the market. These actors are ready to spend unimaginable sums to appropriate the necessary tools in order to stay ahead of the race. Speed ​​has become an essential element, even the heart of high frequency trading today. It is impossible for a human to list high frequency transactions and process their information. The speed has reached a level inappropriate to the primary function of the financial markets. But this practice has become a big problem for some actors and for the financial authorities. It has also acted directly on the markets and caused many dysfunctions and great fears. She has been repeatedly denounced and has been the source of many debates

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