Low Latency 2.0
Posted by Scott Parsons on Fri, Feb 04, 2011
Paul Rowady, TABB Group senior analyst, has a thought-provoking video interview on Tabb Forum entitled Latency 2.0 that we recommend to you.
At Exegy, we strongly agree with some of what Paul puts forth, disagree with other positions; other comments have generated a strong debate in the halls. Here is an example of each.
Paul states early in the interview that the world has shifted to the point that reducing latency is no longer just a competitive advantage but a competitive necessity. We see plenty of validation for this position in our interaction with the market. Customers are moving execution services to colocation venues to reduce execution latency and provide their customers with state of the art trading platforms. The nature of algorithmic trading execution demands that the algorithms respond to changes in fragmented markets as indicated by an ever growing amount of market data. The North American equities and options markets routinely generate 3,000,000 changes to their order books a second. Robust algorithmic trading platforms must efficiently make millions of trading decisions a second in close proximity to execution venues. Why would clients demand anything less of their agents? Why would a broker think that a less robust algorithmic platform will remain competitive? Large buy side firms are now demanding order routing histories for each execution. They are using this information to score algorithmic execution platforms. This is just one example of latency reduction becoming a strategic necessity.
On the other hand, we would challenge Paul’s contention that only a few firms can dominate at the “tip of the (latency) spear”. Certainly, the opportunity set of profitable trades is not declining in this business. At Exegy, we tend to think of this opportunity set as those trades that generate small amounts of alpha with very short holding periods. These periods are probably measured in seconds by today’s risk systems and require access to market data and execution capability measured in microseconds. In the past, the cost of building the technology infrastructure to compete at these levels was expensive and dominated by a few firms. Today, colocation hosting firms offer access to key parts of this technology for as little as $5,000 per month and an ever growing list of prime brokers bundle technologies to provide “best in class” execution systems to their clients as part of their overall offering. Technology is rapidly reducing the cost to compete at the “tip of the spear”.
The largest trading firms do enjoy a competitive advantage from interacting with customer order flow in proprietary dark pools but that is a topic being played out in the US and European regulatory environments. It is easy to imagine that these advantages will be narrowed in the future, expanding opportunities for a plethora of other participants in the low latency trading market.
Finally, Paul’s comments on trading signal generation from news and other asset classes and the need for technologies to adapt to the client’s search for new sources of alpha should spark discussions inside any manufacturer of low latency trading technologies. It happens at Exegy every day, most recently in considering the interaction of foreign exchange signals with equities trading. More on that in a later blog.