THE CHEAT SHEET. Why financial markets want to travel ‘light’

We’ll come to them later, but for now we are discussing the trading fraternity’s obsession with light — the speed of light to be precise.

Because in the world of high-frequency trading (HFT) controlled by machines, speed is king. HFT is basically a system where sinewy computers transact millions of orders at breakneck speed. These machines use complex computing codes (algorithms) to analyse market trends, stocks and economies, and execute trades.

Indeed. In this chaotic world what makes or breaks traders is how quickly the program can analyse stocks, take a call on their value and future, and execute high-volume orders. Mind you, in the US, well over half the trading volumes come from the high-frequency category. So, it’s trillions of bucks we’re looking at. Trading firms hunt for all the latest technologies that can bring down time lags in processing trades. Trading platforms have aided this effort by allowing firms to plonk their servers right next to the exchange servers (co-location) to minimise transmission lags. In this race every sliver of a second counts.

You bet! A report in the Wall Street Journal noted that a few financial-technology startups are now offering devices that can transact at rates matching or even rivalling the speed of light. Some time ago, the Australian firm Metamoko came up with a network switch that could push incoming information to trading servers in just four nanoseconds — that’s four-billionths of a second. The switch could lower the time it takes to execute a full trade to just 85 nanoseconds.

Yup! Chicago-based xCelor is another company that produces a similar gear. Already the industry is using technologies such as cutting edge lasers to speed up their processes. Here, they have taken a cue from US military jets which use laser to communicate as they cut through the sky.

But it’s all about money. Everything’s fair in love, war and HFT — with a caveat. As Michael Reilly, editor of MIT Review , observes, this race to the bottom is reaching the ultimate limits as known physics tells us; that is, light travels about one foot per nanosecond. You cannot go beyond that, unless you break laws of physics, which we lesser mortals are not equipped to do as things stand now.

Now that everyone wants to make money quick and cool, the trading community will not go back on its quest for the fastest technology. Eventually almost everyone will achieve the lightning speed in HFT and there will be a saturation. Reilly feels when everyone trades at light or near-light speed, there will be little advantage to be gained by going any faster.

But this high-decibel play of ultra-fast technology edges out the common folks looking to make a quick buck from markets. Critics of HFT-type fireworks argue that such systems give undue advantage to those who can afford sophisticated technology and hardware infrastructure.

High-frequency traders can play with millions of individual trades in nanoseconds and manipulate the whole system to make billions, leaving regular short-term investors in the lurch.

And that poses a serious threat to the diversity and democracy of financial markets. As Michael Lewis shows us in Flash Boys such trading could be bloody destabilising. That’s one reason why SEBI wants to slow down HFT. But with the trend quite far gone even in India, the alpha males of financial markets are unlikely to learn any lessons, and will continue their race against time.

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