Traduction blog en anglais : Article du site www.captaineconomics.fr intitulé « Trading Haute-Fréquence : A la recherche de la vitesse de la lumière ».
In June 2010, the American company Spread Network inaugurated a new fiber-optic cable connecting Chicago to New Jersey (over a distance of 1330 kilometers), for a total cost of approximately 300 million dollars. The objective: To connect the servers of the Chicago Stock Exchange to those of the NASDAQ (in New Jersey, a few kilometers away from Wall Street) in less than 13 milliseconds roundtrip time, to enable high-frequency traders to exploit potential market anomalies. Just to give you an idea of what that means, 13 milliseconds time to travel 2660 kilometers (roundtrip) is equivalent to a speed of approximately 200.000 kilometers per second: that is close to the speed of light. Behind this figure, there is a phenomenon that took considerable proportions in the last twenty years or so: the importance of the development of infrastructures (fiber-optic submarine cables, relay antennas, microwaves …) and the mad speed race in the world of finance.
The Arbitrage Opportunity
Suppose that an investor wishes to sell a financial asset X at the price of 10 $ in Chicago, and that another investor wishes to buy this same financial asset at the price of 10.01 $ in New York. As a trader, you then have an arbitrage opportunity (an anomaly) you can now buy that asset X at 10 $ in Chicago and resell it at 10.01$ New York: that’s a risk-free profit of 0.01 $ par asset unit. The problem is that you won’t be the only one trying to exploit this anomaly: in order to win, you’ll have to be the fastest. Obviously, I mean the fastest person to detect the anomaly, but also the fastest person to transmit the various buy/sell orders. The transmission of information from a given point A to a given point B depends on physical principles and the system used plays a crucial role.
The Trading Speed Race
In the example of Spread Network, 300 million dollars were invested a fiber-optic system just to be able to gain 0.0000015 seconds with respect to the previous infrastructure. The idea is to take the most direct possible path by going through mountains and below rivers in order to reduce cable length and accelerate the speed of transmission of the information. The following map, extracted of the excellent article “Raging Bulls: How Wall Street got Addicted to Light-Speed Trading”, shows the difference between the previous 1980s cable initially laid down for telecommunication purposes (in red going through Pittsburgh over a distance of about 1000 miles) and the Spread Network cable installed for high-frequency trading (in green, covering the shorter distance of approximately 825 miles).
However, the speed race is not over yet! More recently, another company (McKay Network) installed a series of microwave communication antennae atop twenty towers spread on the way from Chicago to New York to reduce roundtrip time for high-frequency traders by approximately nine milliseconds. This system does however have the disadvantage of being sensitive to weather conditions: any strong storm can impede the function of the system relying on air for the transmission of its communication waves. You may also check “The Micro-geographies of Global Finance: High Frequency Trading and the Construction of Information Inequality” and “Flash Boys – A Wall Street Revolt”.
By the way, and although it is not the subject of this article, it would be interesting to consider the “social value” of investing hundreds of millions of dollars in infrastructure whose unique objective is to gain 0.000003 seconds (3 microseconds) of market transaction execution time (and of the “waste of human capital”). There is no doubt that this activity does create “private value”, both to the companies working on the infrastructure (charging its usage to customers) as well as for high-frequency traders (exploiting market anomalies). The “global value “ is nevertheless rather dubious (financial losses for “low-frequency traders” and naive investors, manipulating the stock markets …).
Anyway, let’s go back to our infrastructures. About twenty years ago, the financial center of Zurich (Switzerland) ranked at the same level as that of Singapore with respect to transaction volume on the foreign exchange market. Today, total transaction amount is nearly two times higher in Singapore. Why? In a very recent article, Eichengreen & al. (source: “Cables, Sharks and Servers: Technology and the Geography of the Foreign Exchange Market, 2016: NBER”) argue that geography is one of the factors explaining the rise of Singapore, London and Tokyo relative to Zurich. But then, what do Japan, the United Kingdom, and Singapore have in common? Well, they are all … islands, while Switzerland is a landlocked country with no access to the sea. Given that it is much easier (and cheaper) to set up a submarine cable system than a terrestrial one (burying of the cables plus other constraints), Zurich had a hard time competing with Singapore as an offshore financial center on the foreign exchange markets.
Having analyzed the effect of installing a submarine cable infrastructure connecting different geographical zones (the first cable having been inaugurated in 1988, connecting New York to Paris, and financed by AT&T, France Telecom, and British Telecom; see: “Submarine Cable Map”), the MIT and BCE authors confirmed that the world is becoming “Flashier”, which means that speed plays an increasingly important role and that the analysis of the infrastructures provides us with a partial explanation to the development of the various financial centers around the world.
In a world of rapidly decreasing technological infrastructure costs (Moore’s law), it would have been possible to imagine a weaker geographical concentration of the financial activities with the reduction of fixed costs (“flatter world”). Instead, the financial system became “flashier”! Execution speed became the key! With an obvious private gain … (and admittedly a positive effect on market liquidity) but with an equally dubious overall “social value”.
Article original : http://www.captaineconomics.fr/-trading-haute-frequence-a-la-recherche-de-la-vitesse-de-la-lumiere.