One of the main advantages of algorithmic trading is speed. To some, it’s so important that an entire sub-section of algo trading, high frequency trading, has rose to prominence because of it. But what is speed? Simply, it’s the ability to access and process information faster than others. The faster one can process information, the faster they can capture opportunities and make a profit.
While the emergence of algorithmic trading is more of a recent phenomenon, leveraging speed to exploit information asymmetries has been central to financial markets since their inception. Here are some examples:
With the Funding Act of 1790, Alexander Hamilton looked to assume the full face value of the various bonds and certificates issued by the Continental Loan Office, along with the various IOUs issued to discharged soldiers and the many debts incurred by state governments. At the time, these paper promises were worth a fraction of their original value, and he proposed that these could be exchanged at a one-to-one rate for new, interest-bearing Treasury bonds issued by the U.S. government. Upon hearing the news, speculators raced to the countryside where the news had not yet spread, eager to buy up as much paper as they could, looking to profit immensely when the act was signed.
Before the electric telegraph, speculators built an optical telegraph line between New York and Philadelphia to capitalize on quick information. But in 1846, the arrival of the electric telegraph took its place. It enabled a new generation of speculators to exploit the new technology in the financial markets.
The race for faster information was prominent even in Europe. The Rothschild banking empire pioneered codes carried by carrier pigeons to get information ahead of the competition, and a system of communication known as the Chappe Telegraph was used to reduce the time a message was transferred from Paris to Bordeaux from days to a few hours. They achieved this staggering speed with a line of signal towers built every 10-20 miles. Operators in each tower kept their eye on the adjacent towers through a telescope, and they used signals to transfer the message at speeds never thought possible. Obviously, the brainchildren of these methods profited handsomely.
What are some of the proposed solutions today? There are currently three fiber optic cables being laid between Tokyo and London. They aim to reduce the latency from 230ms to 170ms, but this project comes at a cost of $1.5 billion. There is also the plan for the Hibernia Express trans-Atlantic cable, which will cut the round trip between New York and London by six milliseconds to 59ms (at an estimated project cost of $300 million).
However there are some alternative solutions that can drop the latency even further than fiber optics. This can be done with microwave networks and soon laser networks. Perseus Telecom recently completed a microwave link between London and Frankfurt that reduced the round-trip latency to just 4.6 milliseconds, which almost halves the 8.35ms it takes for the fiber link to complete a round-trip.
This technology is not new. Telecom companies have used microwave links between cell towers and phone exchanges for decades. However, this network comes with its own issues. Since microwaves are affected by weather and have a low capacity, they’re soon to be replaced with an even faster technology, lasers.
Currently, a select few financial trading firms are now turning to high-speed laser networks between stock exchanges, to decrease latency by a few milliseconds. Laser network technology has the capacity and reliability of most fiber optic networks, with the added benefit of the low latency of microwave networks. A firm called AOptix looks to be the frontrunner in the race to be the fastest with its laser technology. It started off as a US defense contractor, but now it wants to bring this technology to the world of financial trading. They currently hope to roll out some short-range laser links in the US and UK, and then follow up with a London-Frankfurt laser link in the future.
What once played out in weeks and then days now transpires in milliseconds. Will we see trades place in microseconds within the next decade? The brightest minds in the world surely hope to make that a reality.