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The Almighty Buck Businesses

Stock Market Manipulation By Millisecond Trading 624

cfa22 writes "Nice piece in the NY Times today on ultra-fast trading on the NYSE and other markets. The 'algos' that make autonomous trading decisions have to be fast, but I wonder: Is network speed ever a bottleneck? Can anyone with inside experience with millisecond trading provide some details for the curious among us regarding hardware architectures and networking used for such trading systems?" According to the article, high-frequency traders generated about $21 billion in profits last year.
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Stock Market Manipulation By Millisecond Trading

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  • by BadAnalogyGuy ( 945258 ) <BadAnalogyGuy@gmail.com> on Friday July 24, 2009 @09:43AM (#28806975)

    Traders make a profit on each trade. But the profit is always to the broker.

    Ultra fast trading is an interesting idea and done right it can lead to successful short term returns, but if you take a Ferrari around a hairpin at 120mph, you're still going to hit the wall and die.

    • by Mr. Underbridge ( 666784 ) on Friday July 24, 2009 @09:52AM (#28807097)

      Ultra fast trading is an interesting idea and done right it can lead to successful short term returns, but if you take a Ferrari around a hairpin at 120mph, you're still going to hit the wall and die.

      Here's what happens when that particular Ferrari hits the wall:

      http://tech.slashdot.org/tech/08/09/10/203233.shtml

      • Re: (Score:3, Interesting)

        by b4upoo ( 166390 )

        In the US trading done by an automated computer program is illegal. Whether it should be or not I do not know. But apparently drastic market sways were once caused when computers used certain software to control sale and purchases. In order to drop the amplitude and frequency of those sways automated trading was deemed illegal.
        Probably the real world effect of such a law is simply that the big firms must follow the law

        • by jamstar7 ( 694492 ) on Friday July 24, 2009 @01:08PM (#28809933)

          In the US trading done by an automated computer program is illegal. Whether it should be or not I do not know. But apparently drastic market sways were once caused when computers used certain software to control sale and purchases. In order to drop the amplitude and frequency of those sways automated trading was deemed illegal.

          Supposedly, yeah. But the big trading houses are doing this. There is no way a human can do millisecond trading.

          Probably the real world effect of such a law is simply that the big firms must follow the law whereas individuals would probably never be noticed. But with this high speed trading even the little guys might stick out like a soar thumb.

          More like, eaten alive. How many little guys you know have the computing horsepower, software, and bandwidth of one of the major trading houses? Think your 4 GHz Intel box on a cheap DSL can outthink and outmanuever a couple networked Crays on the same T3 as the Exchange? Online trading is quite simply a good way to get eaten for lunch. All it's done is supply more suckers who have NO business in the stock market their opportunity to get bankrupted. And the market is ALWAYS hungry for more suckers. It's the only legal Ponzi scheme out there.

          • by powerlord ( 28156 ) on Friday July 24, 2009 @01:48PM (#28810491) Journal

            Computing horsepower and software yes, Bandwidth in large part, but you're forgetting the critical piece in something like this.

            Lower latency.

            They pay ridiculous sums of money to colocate and get gateways on high bandwidth high speed/low latency networks for market data feeds and trading.

            The smaller brokerage house (if such a thing exists), let alone the day trader/personal trader is so over matched just in terms of how quickly large houses have access to the data, even before you start figuring in things like semi-automated trading algorithms, in-house matching (match sellers and buyers in-house and pocket the exchange's commission for yourself), and the ability to have multiple worldwide feeds to pick from (oh, NY is slower by 3ms today? better switch to the London feed).

            I'm amazed at what is going on in some of these companies.

          • Re: (Score:3, Interesting)

            by jon3k ( 691256 )
            "Think your 4 GHz Intel box on a cheap DSL can outthink and outmanuever a couple networked Crays on the same T3 as the Exchange?"

            Entirely possible, latency becomes the big problem here, not bandwidth. Cheap DSL in the same city as the exchanges could easily outperform an Internet T3 across the country. That'ss why some brokers provision massive point to point optical circuits (think SDH/SONET) to POPs near Exchanges (or directly into them?).
    • by tverbeek ( 457094 ) on Friday July 24, 2009 @09:56AM (#28807129) Homepage

      Can someone explain to me the benefit to society of this kind of activity? I get how the stock market is beneficial, generally allocating resources according to the merit of the business ventures involved, investing capital where it will produce goods/services/jobs, and so on. So despite being a social lefty, I'm not anti-capitalism or anti-stock-market; it has risks and flaws but it works. But how does this kind of stock trading benefit anyone other than the traders themselves?

      • by maxume ( 22995 ) on Friday July 24, 2009 @10:00AM (#28807197)

        In theory it adds liquidity to the market and reduces trading costs for other players.

        Also, many of the successful trades will be based on having better information than the market price (over time, it would be very difficult to have much success by being lucky, especially with multiple automatic systems active), the execution of those trades makes the market price more accurate.

      • Re: (Score:3, Insightful)

        by Culture20 ( 968837 )

        But how does this kind of stock trading benefit anyone other than the traders themselves?

        It doesn't other than inflating/deflating the perceived value of a company. It's a method to speed up the "productive citizens"->"traders/middlemen" transfer.

        • Re: (Score:3, Insightful)

          by phoenix321 ( 734987 ) *

          You can't cheat an honest man.

          If you could make an easy living simply trading stock, everyone would do it. Really, the stock market would be full of people trying to make a quick buck out of nothing. And half of them go broke while the other thrives. The stock market is at worst a lottery or pyramid scheme, but it doesn't bankrupt poor hard working joes if they're working for honest and truthful companies. Or companies that are too small to survive on the publc trade floor.

          But other than that, do you think

          • Re: (Score:3, Insightful)

            by ultranova ( 717540 )

            The stock market is at worst a lottery or pyramid scheme, but it doesn't bankrupt poor hard working joes if they're working for honest and truthful companies. Or companies that are too small to survive on the publc trade floor.

            Except that those small companies operate in an environment dominated by large corporations, which most certainly will engage in all imaginable shenigans to increase their market value so the management gets to cash their stock options. When shit hits the fan, and these corrupt giant

      • by siloko ( 1133863 ) on Friday July 24, 2009 @10:25AM (#28807591)

        I get how the stock market is beneficial, generally allocating resources according to the merit of the business ventures involved.

        I realise I am likely to be charged with trolling [again!] but the stock market now seems to reflect the quality and quantity of ype not products and services. The market capitalisation of dot com companies in particular (AOL is wonderful example) is ridiculous when stacked against their profitability. Nuts and Bolts companies are dull, don't generate headlines and thus don't post great dividends for their shareholders as no-one even cares if they are making a regular profit. Stock markets seem now to be so detached from the reality of the profitability/financial viability of a company that watching the rise of shares to ascertain corporate health is foolish at best.

        I wonder if theses 'algos' have some built in A.I. which parses the days headlines to see if sufficient vacuous hype has been generated to make an investment worthwhile . . .

        • Re: (Score:3, Informative)

          by omnichad ( 1198475 )

          That's the problem with the stock market in general. Stable profit to the company means 0 gain for shareholders. The only way a stock is valuable is for the company to take risks and get bigger and bigger and bigger every year.

      • by SerpentMage ( 13390 ) on Friday July 24, 2009 @10:43AM (#28807877)

        >But how does this kind of stock trading benefit anyone other than the traders themselves?

        How does any trading benefit anyone but the trader themselves? This high frequency trading issue is a moot point. There is nothing sinister about it. What bothers people is that a few are doing it and making oodles of money. I work in this industry and have worked at investment banks where you do high speed trading. But now I work at a hedge fund and we just avoid it. It is an arms race and what bothers people right now is that there is a break in technology capability.

        I am not kidding here. I know for a fact a few houses have been able to get micro-second trades, whereas the rest of the industry is still dealing in milli-second trades. Thus what is happening is that some very very big houses are getting whalloped in a major way. Hence the sour grapes...

      • by Anonymous Coward on Friday July 24, 2009 @10:51AM (#28807997)

        It goes like this. For a given security there are two prices the BID (what you're willing to pay for more of a stock) and the ASK (what you're willing to sell some of the stock you already have for). Most normal folks have only one up at any given time, you're either buying or selling. Then, if a BID equals an ASK you've got a trade.

        There are entities in the market known as "market makers" who do both at the same time, however. They're usually not in the market to load up on a stock or unload their stock, so they try to balance the number of orders filled on a given security by raising their ask or dropping their bid in order to maintain equilibrium. Let's look at an example of an inefficient market without adequate liquidity. Let's say there's only one market maker -- he might bid $1.00 but ask $10.00, and clean up on anyone who tries to do business in his market.

        So my hypothetical firm sees this huge gap and says, "Sweet. Let's start making market in here as well!" -- and I pad my bid a little bit, say $1.05 and shave a bit off the ask, call it $9.95. All of a sudden the original market maker is cut out - none of their bids end up buying stock, none of their asks end up selling it. So they decide to close the gap even further. 1.10 and 9.90. My firm doesn't like getting cut out of this sweet action so we close the gasp further and you have an arms race towards price discovery where the gap between the bid and the ask are separated by a very narrow margin, constantly being adjusted by what actual demand for the security is like.

        Having multiple folks providing liquidity in the market means when you decide you're going to load up on STCK because you think their new product launch is going to do good things for the company your orders are unlikely to drive up the price very much so you can enter the position without paying a big premium to do so. Likewise, a year later you decide you're satisfied with your profits and are ready to exit the position. In a market without this liquidity selling your stock would drive down the price further and cut into your profits on that side.

        Efficient price discovery is the purpose of the market. Liquidity is essential to that end. Traders provide that liquidity and, overall, the market benefits because of it.

      • by cayenne8 ( 626475 ) on Friday July 24, 2009 @11:00AM (#28808137) Homepage Journal
        "But how does this kind of stock trading benefit anyone other than the traders themselves?"

        I think your question speaks (to me at least) of a more basic question. Do all actions have to be to benefit 'others' in your opinion? I think most actions most people take, are soley to benefit themselves....especially where money/wealth is involved. I don't see anything wrong with that...but, it almost sounds like you do?

        Are you implying that nothing really should be allowed to happen unless it benefits society as a whole rather than a single or few individuals?

        Just curious...your question just really struck me strangely what what I thought I heard in it.

        • by ultranova ( 717540 ) on Friday July 24, 2009 @01:48PM (#28810489)

          I think your question speaks (to me at least) of a more basic question. Do all actions have to be to benefit 'others' in your opinion? I think most actions most people take, are soley to benefit themselves....especially where money/wealth is involved. I don't see anything wrong with that...but, it almost sounds like you do?

          There's a difference of scale between the everyday actions of average people and massive manipulation of stock market by rich traders. The actions I take, for example, will significally affect only me and a few other people, who are - and this is the important part - are capable of defending themselves from possible harmful effects, being of roughly equal power than me, or at least in the same order of magnitude.

          On the other hand, as the ongoing recession shows, fucking around with huge economic assets to make a few dollars more can have a massive negative effect on lots of people who have absolutely no way whatsoever to defend themselves from the fallout. And even if they won't lose their job as companies collapse left and right, they still get to pay the bill of trying to keep what's left of the economy from collapsing further, and in time putting it back together - all the while knowing that the next bunch of businessmen is already getting ready to try their "clever" new methods.

          Great power brings great responsibility. People who wield such power but refuse to consider anything except their personal profits are a menace to everyone else, and need to be stripped of enough of that power to no longer be a threat; otherwise you get Enrons. The common way of doing this is through regulating the ways in which power can be used. This is something libertarians, neoliberals and adherents of related ideologues have trouble understanding, presumably due to their failure to comprehend any form of compulsion besides outright violence as an exercise of power over anther.

        • Re: (Score:3, Insightful)

          by KGBear ( 71109 )
          I don't know what the original poster means, but I think I can relate. It's not that all actions have to benefit others; rather it's that some activities are only possible because of what society provides (such as a civilized context in which to trade, including police to make sure someone with a bigger gun doesn't steal your profits). Society provides these things because it gets in return something valuable: price discovery, a more-or-less fair way of allocating resources, jobs, goods, etc. However societ
        • Re: (Score:3, Insightful)

          by Burning1 ( 204959 )

          I think your question speaks (to me at least) of a more basic question. Do all actions have to be to benefit 'others' in your opinion? I think most actions most people take, are soley to benefit themselves....especially where money/wealth is involved. I don't see anything wrong with that...but, it almost sounds like you do?

          It seems like a basic argument behind deregulation and a free market is that the free market makes the best use of people's self interest to benefit the common good.

          When self interest sta

      • by Anonymous Coward on Friday July 24, 2009 @11:32AM (#28808577)

        We did trading similar to this a few years ago, though we used a simple, pure-arbitrage strategy. We were trading the morning of 9/11 (pre market-open - the market never opened that day), and didn't pull the plug when the news hit. We were actually testing feasibility, and had not yet installed our server in a rack in Manhattan. My partner was trading (actually, "overseeing" is a better term) in a day-trading room about 30 miles N of NY. (Later we moved our server to the same building as the Island ECN, which at the time owned the ITCH technology mentioned in the article.). Everyone in the room stopped trading, their jaws dropped, staring at the monitor in the corner. BTW, the consensus in that room that day was that the market was not going to re-open. EVER.

        My partner, though, is sitting in the back of the room, trading away (or, watching the computer trade away), wearing headphones, which already had the other guys suspicious. (The headphones didn't have soothing music, but vocalized order flow information - it was too fast to keep up with visually. My partner did have to intervene when things went awry, and the headphones told him when he needed to act or if things were humming along nicely.)

        I figured later that we did about 5% of the pre-market NASDAQ trades that morning.

        This gave me some consternation for some time. We made a bundle that morning, and the subsequent increased market volatility was the start of a winning streak. We did thousands of trades a day, and simply did not have losing days. Was there a purpose or value to our trading?

        I eventually concluded "yes". We provided market liquidity when it was sorely lacking. The people who sold to us at, say, .50 outside of the market would have sold to somebody else at $1.00 outside of the market had we not been there as a counter-party. We stood there catching hot knives and handing them off, while providing the benefit of a quick and certain sale. This helped reduce spread and volatility.

        Indeed, over the next couple of years, our typical profit/share shrunk from .10-.50 to 1-2 pennies, and competitors entered the market and the war of technological escalation started.

        Now, as for the "flash orders", which apparently started last year, I don't see the benefit of that to the market. It just front-running in exchange for a fee paid for the privilege.

      • Re: (Score:3, Interesting)

        by tmosley ( 996283 )
        It doesn't. Indeed, it is probably fraudulent, as Goldman Sachs has insider information via their better connections to the trading floor than are available to anyone else. Basically, this program takes advantage of the several microsecond delay everyone else is subjected to in order to do insider trading. This doesn't mention the fact that they have access to limit order data that SHOULD be secret, meaning that they know how many shares and when to sell to force down markets, when and where to buy back
      • by DavidTC ( 10147 ) <slas45dxsvadiv.vadiv@NoSpAm.neverbox.com> on Friday July 24, 2009 @12:47PM (#28809653) Homepage

        No, it doesn't.

        I think our entire society (Except stock traders) would be a hell of a lot better off if you were required to own stock for six months.

        People might actually start purchasing stock based on actual company performance. They'd start expecting to make money via dividends, aka, company profit, instead of random fluctuations in the price caused by CEO manipulation.

        Like the CEO, oh, firing half the workforce to cause an upward stock price bump for two months, so they get their bonuses. Oh, and incidentally cripple the company, but what the fuck do they care, they're out the door to another company.

        Stock ownership is company ownership. It is not a fucking bingo game. Although if that existed by itself, that would be fine...the problem is that the idiotic bingo games get play by the board, which starts operating the company for the benefit of the bingo game, instead, of, I dunno, the actual company.

        As a lefty, I'll complain when companies put profits ahead of employees, but hell, they've stopped doing even that. At least that system worked somewhat. Make the workers too unhappy, abuse them too much, and you don't make as much money.

        Now the people running the company are rewarded solely based on an idiotic bingo game, which bears no relationship to how much money the company makes. And it doesn't matter how much the workers abused, because the actual business of actually producing goods and services is irrelevant to the paycheck of the people at the top.

        Until the entire company collapses, at which point they walk out the door with a shitload of money and head to another company, whose board will happily hire them because it will make their stock go up. Which they can sell to poor unsuspecting suckers, and walk away with a lot of money to pour into the next business, building it up as an actual industry, until they can hire a stock-pricing oriented CEO and suck all the cash out of that stock, too.

      • by jollyreaper ( 513215 ) on Friday July 24, 2009 @12:50PM (#28809703)

        Can someone explain to me the benefit to society of this kind of activity? I get how the stock market is beneficial, generally allocating resources according to the merit of the business ventures involved, investing capital where it will produce goods/services/jobs, and so on. So despite being a social lefty, I'm not anti-capitalism or anti-stock-market; it has risks and flaws but it works. But how does this kind of stock trading benefit anyone other than the traders themselves?

        The theoretical benefit of having a stock market is that it allows small amounts of capital from many people to be pooled into larger amounts to undertake business ventures. In private ventures between gentlemen, there wasn't much liquidity (ability to sell stock for cash in an emergency) so there was an understandable reticence to invest too much money in any given scheme. There's also the issue of liability and so forth and how the maximum risk borne by the investor could include his entire fortune.

        So you get the idea of a corporation and the investor's maximum loss is the amount he invested. Put up $10k and it goes tits up, you're only out $10k. Of course, you try setting up a corporation or LLC yourself and get a bank loan and the bank is going to demand you sign a personal letter of credit thus you're back on the hook.

        But let's say you have your corporation, it's not privately held but open for the public to buy shares. You still need the market. This provides a means for the investor to buy shares in your company and an ability to sell them for whatever reason when cash is required. The market for issuing new shares of stock is the primary market; the market for selling outstanding shares is the secondary market. So you feel comfortable buying $10k of Red Hat stock because you know if you ever need access to that money, you can liquidate your position. Your investment strategy would try and anticipate what your cash needs will be -- if you think you'll need it in six months, you're probably in commercial paper, if you need it sooner than that, you might just keep it in the bank.

        All of what I've said above can be good and noble. The problem is that you can end up with people playing with the rules to rig the game. For starters, the stock market was never intended to be the domain of the average citizen. Wealthy individuals and bankers bought and sold stocks, not Joe Public. But Wall Street needs a constant stream of new suckers to take the losing side in bets and so companies started doing the whole 401k thing to get fresh streams of capital to fuck and despoil. And you get the game players who try all sorts of tricks to fuck people out of their positions. Let's also not forget that there are speculators, gamblers, and unsavory business criminals running their little cons.

        It's the same basic human nature that ruins things like insurance. Insurance is a great idea -- you give up a portion of your money and in return you know your ass is covered if the worst possible thing happens. The idea is that only a handful of all the policy holders could suffer at any one time. If you were in an Amish community you could rely on barn raisings and the like and for a business this is the same idea. But then greedy fucks got involved. All the basic scams and cons that could be run against the industry were figured out hundreds of years ago. Buying insurance against something you did not own and did not have an interest in seeing preserved was outlawed by Parliament in what was it, 1790 something? But that's basically what the derivatives crisis is about and it's still legal in America to this day.

        To get wealthy honestly can sometimes come quickly but for most it takes time and effort; to get wealthy quickly usually requires crime and if the crime isn't even against the law, so much the better. Note how the regulations put in place after the Great Depression were lobbied against and removed, thus paving the way for our current mess.

    • by vertinox ( 846076 ) on Friday July 24, 2009 @10:08AM (#28807333)

      Traders make a profit on each trade. But the profit is always to the broker.

      Depends on who your broker is and what kind of account you have with them.

      A true blue day trader is going to have a setup for Direct Access Trading [wikipedia.org] which isn't what you see on TV for those $9 dollar trades for the average Joe.

      It requires you to have more than say $20,000 in the account and you must make a lot daily trades to be eligible, but the transaction fees are very low per trade so you won't be paying as much to your broker (like pennies on the dollar sometimes if volume is high enough).

      • by TooMuchToDo ( 882796 ) on Friday July 24, 2009 @10:33AM (#28807729)
        Thought I'd chime in on this. I have a trading account with $150K+ in it, and my per transaction costs are extremely low (I trade futures though, YMMV when it comes to equities, commodities, etc). The provider I use exposes an API that I can interact against to directly execute trades (although, you're always going to be fighting the speed of light). I wrap around this API with Python and Postgresql. If you're smart and your algorithms are rock solid, you can do well (I don't have to work if I don't want to). On the other hand, you have to make sure a human is *always* in the loop somewhere, otherwise you end up with the United Airlines fiasco someone pointed out above.
        • Re: (Score:3, Insightful)

          by cayenne8 ( 626475 )
          "Thought I'd chime in on this. I have a trading account with $150K+ in it, and my per transaction costs are extremely low (I trade futures though, YMMV when it comes to equities, commodities, etc). The provider I use exposes an API that I can interact against to directly execute trades (although, you're always going to be fighting the speed of light). I wrap around this API with Python and Postgresql. If you're smart and your algorithms are rock solid, you can do well (I don't have to work if I don't want t
        • Re: (Score:3, Funny)

          If you're smart and your algorithms are rock solid, you can do well (I don't have to work if I don't want to).

          Then why do they call you "TooMuchToDo"?

  • by muyla ( 1429487 ) on Friday July 24, 2009 @09:48AM (#28807027)
    In one or two decades we might be able to let all the stock trading to be done by the machines while we focus on doing the non-specialized work ourselfs! Ow wait... wasn't it supposed to go the other way around?
    • Re:Great future (Score:5, Insightful)

      by Nursie ( 632944 ) on Friday July 24, 2009 @09:59AM (#28807191)

      Lol.

      I often do wonder how we ended up here. Most of the wealth of the world is held not by its citizens, but by corporations. Corporations are owned by funds, which are owned by investors which... and by the time you drill through the obfuscation there seems to be nobody that actually accounts for most of the wealth created by the people that actually produce stuff.

      And then you have the wall street leeches who juggle numbers around and suck millions out of... what exactly? The world is not richer for them in any material sense.

      All the while I'm wondering why the day I can retire seems further and further away despite massive advances in technology. Shouldn't we all be creatures of (comparative) leisure by now?

      • Re:Great future (Score:5, Interesting)

        by nelsonal ( 549144 ) on Friday July 24, 2009 @10:17AM (#28807453) Journal
        Pensions and 401(k) plans largely. There's a huge amount of wealth in those. Ironically, the only pensions that act like they give a damn about what they own are the union plans.

        You actually could have a life of comparative leisure relative to the past, but humanity spends huge amounts of time competing with status displays which have become vastly more important to personal happiness in the more "relaxed" world. If you're willing to live a 1950s lifestyle you should be able to have far more leisure time than the 1950s person. Remember though that you'll never leave your home country for travel, live in ~300 sq/person house, share a household immediately after college, and you would probably only own 3-4 suits of clothes.
        • Re: (Score:3, Interesting)

          by bberens ( 965711 )
          You touched on something that scares me and doesn't seem to scare anyone else. The accepted P/E ratios in the stock market are very much supply and demand based. There's a lot of demand for shares because baby boomers are investing in their 401ks. When they massively pull out of the market, demand is going to drop significantly. We'll run into the same problem everyone is talking about with Social Security, but it's going to be our 401ks. In this way, the stock market also behaves like a ponzi scheme.
  • by Anonymous Coward on Friday July 24, 2009 @09:50AM (#28807061)

    Stock Trader Just got a Headshot - $3000

    SEC Official: I see you over there...

    Stock Trader: I'm not hacking, I'm just lagging!

    SEC Official: Turn them off, or I'm banning!

  • I believe that precision millisecond stock trading globally is the real reason behind the IEEE 1588v2 precision time protocol. The cisco 9000 enterprise switch supports it. Support has been lacking in smaller switches. The only other group using PTPv2 is the cell phone industry.

    The interesting part of PTPv2 for me is that it is used in the 802.1AS protocol ( http://www.ieee802.org/1/pages/802.1as.html [ieee802.org] ) which is one of the foundations of Audio Video Bridging (AVB) http://www.ieee802.org/1/pages/avbridges.html [ieee802.org] - Which allows for real time low latency low jitter media streams transported via ethernet with guaranteed bandwidth.

    Just yesterday I was joking with friends: Forget about stealing the rounded pennies from bank accounts, criminals could re-program the PTPv2 implementation in switches to steal milliseconds of time during trading!

    Anyways, back on the original question, no, network speed is not so crucial once all of your packets are properly timestamped.

    --jeffk++
     

    • by TubeSteak ( 669689 ) on Friday July 24, 2009 @10:14AM (#28807399) Journal

      Anyways, back on the original question, no, network speed is not so crucial once all of your packets are properly timestamped.

      RTFA:
      One second after the market opened, shares of Broadcom started changing hands at $26.20.
      ...
      While markets are supposed to ensure transparency by showing orders to everyone simultaneously, a loophole in regulations allows marketplaces like Nasdaq to show traders some orders ahead of everyone else in exchange for a fee.
      ...
      Automatic programs began issuing and canceling tiny orders within milliseconds to determine how much the slower traders were willing to pay. The high-frequency computers quickly determined that some investors' upper limit was $26.40. The price shot to $26.39, and high-frequency programs began offering to sell hundreds of thousands of shares.

      On the one hand, you can call this 'perfect price discovery'
      OTOH, that specific set of behaviors fundamentally breaks the traditional way that the imperfect markets have worked.
      And just as importantly, it represents an unfair trading advantage that you or I will never have.
      Allowing this behavior doesn't further market activities, it just allows a few players to accumulate wealth at everyone's expense.
      Seems to me that the solution is to close the loophole that allows this to happen.

      • by 31415926535897 ( 702314 ) on Friday July 24, 2009 @01:41PM (#28810395) Journal

        On the one hand, you can call this 'perfect price discovery'
        OTOH, that specific set of behaviors fundamentally breaks the traditional way that the imperfect markets have worked.
        And just as importantly, it represents an unfair trading advantage that you or I will never have.
        Allowing this behavior doesn't further market activities, it just allows a few players to accumulate wealth at everyone's expense.
        Seems to me that the solution is to close the loophole that allows this to happen.

        As an investor (which is the term the article is using--among whom are you and I), you had better not be trading like these traders. These traders are Market Makers [wikipedia.org], which are specialized traders that provide liquidity (a very important thing) to the market. If you don't have real market makers, then the stock market is going to look like what Mortgage Backed Securities look like right now: there will be periods of time when nobody wants to touch the stuff, and if you are an investor, you are truly screwed if you need to buy or sell your security.

        These market markets are looking to capture a spread (the cost to buy or sell)-which by the way is much better for the investor than 5, 10 or 20 years ago--capturing a fraction of a penny a billion times a day. The key component to a market maker's success or failure is understanding supply and demand. This was true even before the computers came in. The computers can only detect it much faster, so you get what you mentioned first--better price discovery. It's not that the investor is getting screwed out of 20 cents, it's that they're not getting the 20 cent discount they used to when the market makers were humans standing in the pits.

        As an investor, you really shouldn't care if you get Broadcom at $26.20 or $26.40. Yeah, it's nice if you get it for the cheaper price, but the reason you're buying Broadcom is because you think it's a good investment, and if $0.20 ruins that investment for you, then I guarantee it's not a good investment.

        The $0.20 might ruin a day-trader's day, but day-traders are not investors nor market makers. You and I are not day traders. The only thing the electronic market makers ("high-frequency traders") ruin are slower, human-based market makers' profits and day-trader's profits. It's certainly not worth an article in the New York Times.

  • by WipeLeftShakeRight ( 1565507 ) on Friday July 24, 2009 @09:52AM (#28807093)
    I interviewed at a millisecond (market-making) trading firm in Chicago. They claimed that when a hedge fund, etc. would buy or sell a stock, that one large purchase or sale would typically signal another. Whichever firm could get their quote up the fastest would make the buy or sale, and it's a winner-take-all system. The first market-maker to adjust their price would benefit. Thus, server speed is THE essential bottleneck. Needless to say, they keep the location of their server a secret.
  • by axafg00b ( 398439 ) on Friday July 24, 2009 @09:55AM (#28807123)

    A firm I worked with recently tore down an arbitrage network (they were getting out of the business as it was not core) which comprised of a great deal of Layer 2 dark fiber between sites in NYC and an external data center in NJ, Force 10 fabric switches with multiple paths to server clusters, and a great many Sun X-series servers running Linux. This arbitrage network bypassed the standard corporate (i.e. Cisco-based) network as they wanted exclusivity, higher bandwidth and as much speed as possible. Still, there were issues and the whole environment was scrapped since the actual returns did not match the expectations or cover the costs.

    When I looked over the shoulders of the designers (they didn't want too much support from the regular network engineering team) they were concerned with raw performance and not as much with security or other daily operational issues. I would characterize it as the difference between, say, a NASCAR Sprint Cup car and your regular transportation. The former is purpose-built solely for performance while the other has to contend with safety requirements, daily functionality, and a lower common denominator for use.

    • Re: (Score:3, Informative)

      by mikael ( 484 )

      Most of the safety innovations for private cars came from the racing car industry - roll bar cages, seat belts, crumple zones, safety glass. Roll bar cages and crumple zones and safety glass have been into train carriages as well.

    • Re: (Score:3, Funny)

      by aclarke ( 307017 )

      I would characterize it as the difference between, say, a NASCAR Sprint Cup car and your regular transportation. The former is purpose-built solely for performance while the other has to contend with safety requirements, daily functionality, and a lower common denominator for use.

      So what you're saying is that the dark fibre packets could only turn left?

  • by Anonymous Coward on Friday July 24, 2009 @09:56AM (#28807133)

    Allston Trading occasionally speaks at my university, and they've said that network bandwidth can be a big bottleneck. They needed to install servers across the street from the NYSE to attain the edge they needed.

    As far as who the profits go to, ALlston (and I suspect many similar organizations) keeps most of their profits internal, and exercise big profit-sharing programs for their employees. It's actually quite an interesting idea, as this group of almost entirely Computer Scientists are using their expertise to make some good money as a cell in an atmosphere dominated mostly by business-types.

  • Some info (Score:5, Interesting)

    by Haffner ( 1349071 ) on Friday July 24, 2009 @09:58AM (#28807165)
    As someone who works with people who do this, I can tell you they spend a lot of money on very powerful machines, and then try to place said machines within walking distance of the exchange's computers. I have been told that running a server at the office is too slow, even if its in the same city. Also, millisecond is the wrong word. Their trading is measured more closely in microseconds.
    • Re: (Score:3, Informative)

      by niola ( 74324 )

      Yeah from some of the stories I have been following on this, it seems some firms even co-locate their machines in the same room with the NYSE trade systems. I imagine that could be quite an advantage over other traders, especially when coupled with some extremely high performance program trade code like Goldman Sachs has been using.

      http://www.reuters.com/article/fundsFundsNews/idUSN0518022220090705 [reuters.com]

  • FAZ and FAS funds (Score:3, Interesting)

    by vertinox ( 846076 ) on Friday July 24, 2009 @09:59AM (#28807175)

    This has been a common topic on the stocks news groups about FAZ [google.com] and FAS [google.com] using different methods because of inefficiency between the two funds.

    They are support to inverses of each other (short and long) of the finacial markets with leverage, but a few people have noticed that during the first minute of trading they aren't exactly the same.

    The basis of the what people are doing is complicated and usually involves buying both shares and dumping one in the first minute and then selling the other shortly thereafter.

    But there are other methods people have talked about but I can't seem to find the newsgroups since they were buried in spam a month or so ago.

  • not first (Score:5, Funny)

    by Permutation Citizen ( 1306083 ) * on Friday July 24, 2009 @10:00AM (#28807203)

    I suppose that's the same guys that are always getting the "first post" on /.

  • by GlobalEcho ( 26240 ) on Friday July 24, 2009 @10:00AM (#28807207)

    I work in the finance industry, and know a few things about this business. It can be very profitable indeed. Since the HF trades are typically finished at the end of each day (or even minute), they are not required to hold much cash (capital) to support their positions. Thus the business is unusual in the finance world for making a profit on, essentially, zero capital. Of course, it costs a lot of money to stay in the arms race.

    The article hints at two kinds of HF strategies, and they really are distinct. First, there are the "rebate" strategies that collect those credits for providing markets. Then, there are the "predatory" strategies that try to find the price points of buyers and sellers as described. Other HF strategies include pairs trades (Exxon goes up so RIG will soon), inter-exchange arbitrage where a stock is traded on multiple exchanges, and index arbitrage such as trading the elements of the S&P 500 against the index futures (which has been around almost forever).

    Other algorithmic trading includes strategies meant to take on positions slowly (or quickly) and efficiently. A famous old category are the Volume Weighted Average Price (VWAP) strategies that try to trade a little bit at a time throughout the day, so that the average trade price is close to the day's average. Other algos try to take advantage of mean reversion or trends during the day.

    There is huge demand for technical people in this industry (I probably get one headhunter call every two weeks), almost all of it in NYC or Chicago. There's demand for network engineers, statisticians, programmers, and traders, and high pay for quality. Surprisingly few programmers these days are really acceptable to the business, because the code has to be so fast and efficient, and almost no one studies that any more.

  • The short answer (Score:5, Informative)

    by sjvn ( 11568 ) <sjvnNO@SPAMvna1.com> on Friday July 24, 2009 @10:00AM (#28807209) Homepage

    Most exchanges aim for that kind of speed now, but fail to make it. Some of them, like the London Stock Exchange, http://blogs.computerworld.com/london_stock_exchange_to_abandon_failed_windows_platform [computerworld.com], which made the idiotic mistake of relying on Windows Server and SQL Server, don't even come close to delivering that kind of performance.

    For those that come closest, the servers tend to be transaction-optimized RHEL (Red Hat Enterprise Linux) and Solaris. The networks are fiber optic-based. While they may connect to the Internet, the core systems, like those provided by AboveNet, are usually private 10GBe networks. In short, to really take advantage of this kind of high-speed trading you're not going to be doing this from your basement. You need to have a trading station either co-located at the market, or just down the street on a high-speed network no more than a link or two from the exchange's servers.

    And, yes, network speed does matter here. So does server, storage and DBMS access speed.

    Needless to say, none of the exchanges are exactly forthcoming about what their particular magic technology formula is since being able to deliver high-speed trading consistently has become an important sales point. I know many traders on Wall St. and the City in London who will move from one Exchange to another based purely on their ability to deliver faster trades. For this group, what's being traded is besides the point. It's all about keeping an edge in trading speed over their competitors.

    Steven

  • Speed is important (Score:4, Informative)

    by LearningHard ( 612455 ) on Friday July 24, 2009 @10:03AM (#28807263) Journal
    To a previous commenter. The companies doing high frequency trading "are" the brokers. They aren't paying any brokerage fees because they have direct access to the market. Additionally speed is important enough that your computers need to be at least in the same physical vicinity as the trading computers. Literally every millisecond makes a difference. One of the things explained in the article is because the computers are so fast they can issue and cancel an order before it gets fulfilled. So with the Intel example: Notice there is a large buying trend in Broadcom Issue at x and see if there is a match. When a match is found immediately cancel. Issue at x+1 and see if there is a match. When a match is found immediately cancel. Repeat until a match isn't found. Place a huge sell order at the final number a match was found. PROFIT Basically the company made a .4% profit in a few seconds on 1.8 million by doing nothing but taking advantage of proximity to the market. This runs against several of the ideas around how an exchange is supposed to work. By the way... if I remember the match correctly that small .4% profit? It becomes huge when you consider this is done every second of every day. All that money those big firms are sucking up are coming from the small investor. The question is what is there to do about it? It will kill any small time daytrader. Someone like me who buys and holds will be alright but man forget trying to trade minute by minute based on technicals.
  • by Whatsisname ( 891214 ) on Friday July 24, 2009 @10:05AM (#28807297) Homepage

    This kind of activity is an abuse of the free stock market system.

    This activity does not generate wealth. It doesn't create something from nothing. And it doesn't add value to society. If they generated 21 billion, then 21 billion was necessarily lost by others.

    People should look down on this kind of business and method of trading.

    • by Will Fisher ( 731585 ) on Friday July 24, 2009 @10:22AM (#28807533)

      You're wrong.

      High frequency trading means that more trades happen in general. This extra competition to fill orders drives down the difference between the buy and sell prices and greatly reduces arbitrage situations (ie, the difference in price between the same stock listed on different exchanges and possibly in different currencies).

      So, if you buy or sell a something, you're giving less money to the market-makers and you're getting a more "correct" price. It levels the playing field.

      And it's true that arbitrage and hifi trading are a zero-sum game. That's why it's an arms-race at this point.

      • by jdev ( 227251 ) on Friday July 24, 2009 @11:08AM (#28808239)
        You're wrong.

        High frequency trading is based on exploiting knowledge that isn't available to everyone. Its akin to insider trading and should be regulated.

        Lets say that a company announces something that means big profits. Lots of people then place orders to buy. Due to a special agreement with NASDAQ or whoever, a high frequency trading program will see these orders getting ready to be placed and make their orders a fraction of a second before everybody else. So they get the stock for slightly cheaper and then sell it off quickly for a profit. They end up making money off the people that don't have access to high frequency trading. They don't make a lot off of each trade, but they make up for it in volume.

        If this is allowed to continue, the markets will lose their credibility. Hopefully they will either self regulate or government intervention will take care of the problem.
    • Re: (Score:3, Informative)

      by vertinox ( 846076 )

      And it doesn't add value to society. If they generated 21 billion, then 21 billion was necessarily lost by others.

      Actually, the stock market is not a zero sum system.

      When people and mutual funds lost all their 401K value (billions even) in 2008, no one actually got that money.

      Not the hedge funds.
      Not the short sellers.
      Not the government.

      It simply vanished.

      Which is why had major deflation.

      The issue is that the stockmarket doesn't make money like say the Federal Reserve prints it, but in a sense it basically s

  • by nweaver ( 113078 ) on Friday July 24, 2009 @10:09AM (#28807355) Homepage

    Front Running [wikipedia.org] is when the broker or market maker (eg, Nasdaq) does such behavior.

    Although the high frequency trading is slightly different, it is almost electronic front-running, especially with the ability to PULL the orders unfufiled after a few milliseconds.

  • by DCFC ( 933633 ) on Friday July 24, 2009 @10:13AM (#28807387)

    This is an outstandingly bogus article, what happens when arts graduates attempt to understand anything except celebrity gossip.

    >It is the hot new thing on Wall Street,
    The first algotrading I encountered was in the early 1990s at Deutsche, and they senior guys there told me of some of the mid80s stuff they'd done.
    Not new.

    >a way for a handful of traders to master the stock market,
    Although algotrading is not exactly mass market, it is about as exclusive an activity as getting drunk.

    >peek at investorsâ(TM) orders
    That's not algotrading.

    >and, critics say, even subtly manipulate share prices.
    A major topic in algotrading is actually market impact modelling, ie working out how to make prices move less when they trade.

    >Nearly everyone on Wall Street is wondering how hedge funds and large banks like Goldman Sachs are making so much money so soon after the financial system nearly collapsed. High-frequency >trading is one answer.
    Actually they're working out how to employ these guys since they've often been shafted by the GS bonus scheme.

    >software that a federal prosecutor said could âoemanipulate markets in unfair waysâ â" it only added to the mystery.
    He was fed this line by GS as part of a dispute over an algotrader's pay. There is no suggestion that GS was being "unfair", just addressing the issues caused by GS having an inferior tech infrastructure for AT than may competitors.

    >"This is where all the money is getting made,â said William H. Donaldson".
    I'd love to see the original quote before editing. Bet it was a lot less sexy.

    >For most of Wall Streetâ(TM)s history, stock trading was fairly straightforward:
    For an arts graduate the writer is terribly ignorant of history, as well as trading.
    For instance is he not aware of how the Kennedy family got rich as part of causing the crash of 1929 ?

    >Joseph M. Mecane of NYSE Euronext, which operates the New York Stock Exchange. âoeMarkets need liquidity, and high-frequency traders provide opportunities for other investors to buy and sell.â
    It's more complex than that. Some ATs are consumers of liquidity, others provide it, and there exist models that imply that heavy AT activity drives liquidity away.

    >Average daily volume has soared by 164 percent since 2005, according to data from NYSE. Although precise figures are elusive,
    164% is a surprisingly "precise" figure, which PR bunny fed that to him ? Wonder why the PR wouldn't give more ?

    >"The result is that the slower-moving investors paid $1.4 million for about 56,000 shares, or $7,800 more than if they had been able to move as quickly as the high-frequency traders."
    That's really quite amazingly precise. So precise that I believe not a word of it.
    Edit/Delete Message

    • by amateur6 ( 1597289 ) * on Friday July 24, 2009 @11:07AM (#28808223)

      You seem to delight in the fact that the author got an undergraduate degree in History before his Harvard MBA. Either you have an MBA from a competing school, and think that Harvard MBAs don't have to work as hard as other folks, or you have NO MBA, and believe that your "life experience" is better than any graduate degree. Neither qualifies you to judge "arts graduates" as a whole.

      This is an outstandingly bogus article, what happens when arts graduates attempt to understand anything except celebrity gossip.

      >"The result is that the slower-moving investors paid $1.4 million for about 56,000 shares, or $7,800 more than if they had been able to move as quickly as the high-frequency traders."
      That's really quite amazingly precise. So precise that I believe not a word of it.

      Yes, by all means let's distrust "precise" figures -- you probably ignore facts as well.

      I can arrive at a slightly more accurate figure with some simple math. The stock opened at $26.20. The threshold being exploited was $26.39, 19 cents above the opening price. If we allow a for a 5 cent rise from the opening stock price (supposition on my part, but I think it's reasonable to guess that the price moved before the exploits occurred), then the algos gained $0.14 per share on 56,000 shares (from TFA), equaling -- huh, look at that -- $7840.

      Not bad for a BFA, if I say so myself.

  • by Maxo-Texas ( 864189 ) on Friday July 24, 2009 @10:21AM (#28807519)

    GS sees both the buy order and the sell order.

    They can sell before large sell orders. Then buy again after to avoid a loss.
    They can buy before large buy orders. Then sell right after to take a gain.

    It's called front running and it's illegal.

    But the government is not enforcing the law.

    My theory is they are letting illegal activity go on to hold up the market prices.

    I could be paranoid. But I've been in this thing for 28 years now and I've never seen such goofy market behavior and repeated evidence of price manipulation at market close on thin volume-- and yet there are no investigations.

  • by cexshun ( 770970 ) on Friday July 24, 2009 @10:34AM (#28807733) Homepage

    I was a Sys Admin for a day trading company in Chicago.

    We had a 100mb serial line direct to all of the major markets that we traded in. We also traded the European markets. Trades were taking upwards of 300ms to complete. So, we spent $25mil USD to build a data center in Germany. We could then use Citrix to remote into this data center and trade, We still had traders that would scream for us when a trade took >100ms on the local markets. And we came running and scoured network logs trying to find the bottleneck.

    We replicated all traffic to certain ports on the Cisco and had Wireshark running constantly, even after hours. Every millisecond counted. And seeing that the owner of the company personally made $3mil profit every quarter, it seemed to be working.

  • Welcome to 1992 (Score:4, Interesting)

    by ajs ( 35943 ) <[ajs] [at] [ajs.com]> on Friday July 24, 2009 @10:39AM (#28807827) Homepage Journal

    We had a couple of mini-meltdowns of the market in the early 90s because of programmed trading that went haywire. Ever since, programmed trading and the arbitrage that comes from out-pacing the market by a few seconds (at first, and then a few tens of seconds and now milliseconds), there has been an ebb-and-flow that looks like this:

    * Someone starts doing this (they think it's the next big thing)
    * They run into problems, and accidentally make the news
    * The news media is all shocked that this new thing is happening
    * The company (or project) that started it either goes away or settles down and becomes a mature member of the programmed trading community.

    The interesting story, and the one never covered is the nature of the mature community. They essentially have a shadow-stock market that hasn't fully been regulated, and which is literally invisible to most humans. Now, these companies are mostly very large and stable organizations that want to stay that way, so for the most part, they implement controls that are sane, but as we've seen over the past few years, systemic mistakes which have no obvious downside until they cause wide-spread failure are not typically regulated well from the inside (alas poor Lehman, I knew you).

    However, we should be clear here: this arbitrage is very often not as valuable as you would think. It costs a lot of money to do and has fairly small margins of return. It makes money, but there are easier ways to make money in the market. On the other hand, it has the virtue of very high turn-over, which means you can throw a pretty sizable chunk of money at it. When you're a large investment firm saying "sizable chunk of money," you typically mean, "dang, they won't let me buy more than 10% of IBM in this fund."

    • Re: (Score:3, Informative)

      by ajs ( 35943 )

      Correction: I'm told I'm behind the times. The current advantage is in microseconds, not milliseconds.

  • by miller60 ( 554835 ) * on Friday July 24, 2009 @10:52AM (#28808021) Homepage
    Automated trading has been a growth engine for data center colo providers, who market "proximity hosting" [datacenterknowledge.com] space within their facilities to hedge funds who believe that they can get an edge by being physically closer to the exchange's servers than their trading rivals. In other words, once you max out the wire speed, it's about physical distance. Savvis says its ultra-low latency offerings can reduce connection speed to microseconds, rather than milliseconds. The NYSE's data center expansion purportedly will enable it to offer colo space to low latency trading operations.
  • by knapper_tech ( 813569 ) on Friday July 24, 2009 @01:49PM (#28810499)
    Whenever a stock is in the soft parts of the price elasticity curve, sensitivity to fundamentals is low and the trading can be manipulated by applying the correct trades at the correct technical points. The method involves representing all traders and trading accounts as one aggregate trader with an average propensity to respond to technical signals and then using this theoretical trader as a model to predict which trading contention points will be most influential on the developing technical pattern. If a stock is trading well within its plausible valuation range, this technical response sensitivity is the dominant mechanism driving new trades. You can draw the stock market as a control function and solve for the type of feedback necessary to induce the desired trading pattern. Engineers who do analysis of oscillations of mechanical or electrical systems will understand this readily.

    Whenever a stock is deep on either side of the price elasticity curve, the influence of fundamental traders will present too much of a "noise" signal for technical manipulation to be effective. I'm writing up a on this subject here. [blogspot.com]

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