Data Latency Playing An Ever Increasing Role In Effective Trading

Wall Street’s quest to process data at the speed of light relies on the physical proximity of servers to overcome the technical barriers of data latency.
By Richard Martin, InformationWeek
Wall Street & Technology
May 25, 2007

http://www.wallstreetandtech.com/showArticle.jhtml;jsessionid=MMCMY42Y0Q0QCQSNDLPSKH0CJUNN2JVN?articleID=199702208

This article explores the importance of increased communication and efficiency in the securities markets through electronic trading. Electronic trading is seen by some brokers as a threat, and this is not unfounded since there has been a one fourth reduction in the number of floor traders in the NYSE over the past year. Electronic trading now accounts for 60-70% of trading in the New York Stock Exchange.

Yet overall, automated decision-making and execution systems have increased the efficiency of the trading process and reduces huge swings in the market when a backorder of buy or sell trades are executed. Electronic trading leads to greater smoothening and stability of financial markets.

Richard Martin, the author of the article, also stresses that speed is a major issue for firms in increasing their competitiveness in the market: “a 1-millisecond advantage in trading applications can be worth millions of dollars a year to a major brokerage firm.” Reducing latency is the time it takes for orders to get processed from execution to confirmation. It could mean the difference of securing an order at the best price.

This can be achieved by locating firms algorithmic data and processing centers as close to the exchanges as physically possible. Exchanges have also benefitted from this co-location of servers with exchanges, by charging firms for this service Stock exchanges have seen a 20-30% increase in revenue from such activities.

CEO and founder of BATS (Better Automated Trading System), believes that the goal of latency reduction will continue and will be never-ending. He quotes as saying: “If anybody knows how to get a signal transmitted faster than the speed of light, I'd like to talk with them." He is a big proponent of ultra fast trading and using electronic trading platforms and feels that Wall Street needs a change. Nasdaq has also been forthcoming in its acceptance of using technology platforms and electronic trades.

This article highlights the fact that technology is a key aspect in trading and is the way to the future of stock trading. With the global direction of breaking down barriers to capital markets in terms of “political, geographical, institutional and political barriers” to increase transparent and fair markets, electronic trading is in stride with this goal. Also with technological breakthroughs there could be a possible move to 24 hour trading.

However, there comes a point where there will be diminishing marginal returns in latency reduction from sub milliseconds, and this cannot differentiate your company from the next. Customer service and other old-fashioned techniques such as market know-how will come into play again. Personally, I think electronic trading can stabilize financial markets, reduce transaction costs, and creates a more civilized trading atmosphere other than what is seen in some stock markets in an auctioning environment, where the atmosphere resembles more of a fish market. The US exchanges are in stark contrast to other exchanges around the world such as the Hong Kong Stock Exchange, where there is no auctioning pit. Electronic trading I believe creates more order in stock trading practices.