Financial transactions such as buy and sell orders just years ago took minutes or hours to transact. They not take less than a second.
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Data at the Speed of Light
In a vacuum the speed of light is roughly 300,000 kilometers per second. With today’s latest technologies such as fiber optics and state of the art routers and switches, data transmission speeds of 100,000 kilometers per second. At this rate, it takes a packet of data 44 milliseconds to go from New York City to Los Angeles. A round trip transmission is roughly 90 milliseconds. Because the transmission time, or latency, is a function of distance, it can be be proven that proximity is a huge advantage in time sensitive high frequency trading.
Algorithmic trading is a specialized type of high frequency trading. This trading strategy utilizes ticker tape data before it is available to most human eyes. Custom designed algorithms watch for certain cues such as order sizes, order velocities or order prices and take their positions based on this information. Because algorithms are designed to use ticker tape data, the closer the computations are performed to the data source, the better.
High speed internet and advanced computers have allowed the introduction of self service online brokerages. These brokerages feature reduced commissions and nearly instant transactions. Specialty shops employing high frequency trading strategies have claimed that they help improve market liquidity, but critics have also been quick to note that high frequency trading has led to increased market volatility.
With the advances in technologies stocks prices are measured in fractions of a cent on certain markets. For a retail investor, a tenth of a cent gain sounds insignificant, but to a trader working in 1,000 share lots averaging 100,000 trades per hour, it sounds like a significant profit. Faster transactions allows for a higher volume of trades, with each trade accepting a smaller margin. Without human intervention, trading algorithms are able to achieve a large number of small gains, adding up to a large total gain.
The ethics and legality of time sensitive high frequency trading are a huge concern for the general public as well as regulatory commissions such as the SEC. High frequency trading strategies may enter and abandon a position within seconds, using data that may not be available to unsophisticated traders for minutes. This "pay to play" system has been questioned by many, because it gives significant advantages to those with superior technology.
Chicago Mercantile Exchange Colocation
Because proximity to the trading floor directly influences the time it takes to place orders, it is advantageous to be as close as possible to the exchange. The markets themselves know this and have began to offer the ability to rent space to locate servers in the same building as the exchange itself. Because of the profitability of many high frequency trading operations and limited space, this space typically features an enormous price tag.
Direct Market Access and Ultra Low Latency Trading
In certain circumstances, trading shops are granted direct access to the market’s order queue, allowing for trading times of less than 500 microseconds, or .5 milliseconds. These speeds are faster than humans can even think. A human has a visual response time of approximately 100 milliseconds, not including time to process data or decide which action is necessary. Direct market access trading operations can receive data, decide which operation to perform and send the command before a human is able to even see the data flash on the screen.
Technology has improved significantly in the last decade, but it appears to have reached a plateau. Trades can already be placed at nearly the speed of light, meaning that improvements in speed can only come from processing speeds or data read/write improvements such as with solid state disks.
This article was contributed by Jeffrey Fabrini, a freelance writer who focuses on technological innovations in finance, financial regulation, stock markets, and other related matters. Those interested in learning about credit and credit improvement should view the resources at kelcreditrepair.com.