“This Is Where All the Money Is Getting Made” Those were the words of William H. Donaldson, former chairman and chief executive of the New York Stock Exchange, on high-frequency trading. High-frequency trading experienced a growth of approximately 164% between 2004 and 2009, according to data from the New York Stock Exchange
Following the adoption of computer technology by exchanges, high-frequency trading was developed in the 1990s. Thanks to the advances in computer technology, trading desks have been able to increase capabilities and profitability. High-frequency trading enabled trading desks to deal with large volumes and execute trades with precision and immediacy. What started with basic order processing systems has grown to become a multi-billion dollar industry that relies on full-fledged state-of-the-art trading systems. In terms of value, the Tabb Group estimated that high-frequency trading made up 56% of equity trading in the United States and 38% in Europe in 2010. High-frequency trading can be executed globally, 24 hours a day, five days a week through worldwide electronic exchanges. Progress made in infrastructure technology has, for example, made it possible for electronic information to make a round trip between London and New York City in under 65 milliseconds. Round the clock trading has given trading desks multiple benefits:
- Capitalization on foreign market opportunities;
- Trading in higher volumes resulting in higher revenues;
- Optimization of international trading strategies and algorithms; and
- Risk mitigation on volumes traded.
THE RACE TO ZERO
Keeping up with technological advances and international market opportunities requires a continuous commitment and the best possible infrastructure. High-frequency trading takes advantage of latency arbitrage, i.e. being able to buy or sell faster than competing market participants who do not have the means to identify and react to changes as rapidly. In a game of microseconds, the speed at which a trading desk can execute an order from its computer to an electronic exchange can be the difference between a profit and a loss. From an infrastructure point-of-view, trading desks are faced with two main challenges. The first challenge is finding and selecting strategic trade locations. Globalization of the trading industry has placed a premium on proximity to electronic exchanges. The second challenge is establishing optimal connections between trade locations. The goal is to gain a competitive advantage through the lowest possible latency. A reliable infrastructure is instrumental for trading desks to execute their strategies and realize a positive return on investment (ROI). There are three key areas trading desks should take into consideration when choosing the right infrastructure provider:
“A reliable infrastructure is instrumental for trading desks to execute their strategies and realize a positive return on investment.”
Latency plays a fundamental role in the technology arms race. In the competitive market space of high-frequency trading, it has become a game of “how low can you go?”. Even a minute difference of a few milliseconds or even microseconds in latency can lead to a substantial competitive edge. Having a non-optimized latency can render entire trading strategies and algorithms worthless. Achieving success in high-frequency trading requires continuous latency optimization. Trading desks can win the race to zero by partnering with vendors who constantly implement improvements, innovations and new developments throughout the technology’s lifecycle. It is important to consider where latency matters the most and how it can be minimized. Whether it concerns a connection between a datacenter and an electronic exchange or between datacenters at multiple locations, the challenge is to map the ideal connection route.
Back in the day, traders looking a competitive edge would rent space next to the exchange and drill holes in the wall to eavesdrop. While practices like these do not take place anymore, the principle still stands. High-frequency trading can be executed from anywhere in the world, but the key to capitalizing on global market opportunities is proximity to local exchanges. Modern day traders rent space at datacenters that are located very near electronic exchanges. Datacenters have become cost-effective interconnection hubs for networks and services. For trading desks, their proximity to local electronic exchanges minimizes latency in transactions. There are 384 electronic exchanges around the world and— through datacenters—trading desks can seize opportunities in both existing and new markets. Leveraging worldwide exchanges allows trading desks to access and react to market movements around the world. This diversification helps traders mitigate risks as well as drive trade volume and revenues.
CARRIER-NEUTRALITY Today’s trading ecosystem consists of a multitude of companies who all play an important role in the entire process including trading desks, electronic exchanges, market data vendors, network operators and technology providers. One of the keys to maintaining and growing the symbiotic relationship between these parties is carrier-neutrality. Carrier-neutrality provides maximum choice as well as equal market access to all participants. This attracts a critical mass of parties that grows and diversifies. This gives incumbents an opportunity to grow future business operations through more choice of whom to partner with. The desire to gain a competitive edge through ever-increasing processing power, throughput and speed-to-market has made carrierneutrality a cornerstone concept in high-frequency trading. Considering the three factors (latency, globalization and carrier-neutrality), trading desks should consider neutral datacenters. Neutral datacenters are part of a worldwide network that is interconnected through low-latency, highavailability links. Proven solutions at one datacenter can be instantly replicated at another datacenter. This creates simplicity and cost-effectiveness for trading desks that are seeking to differentiate on global trading opportunities.