Relativistic trading: The speed of light isn't fast enough for some market transactions

Nov 13, 2010 By Phillip F. Schewe
Optimal intermediate trading node locations (small circles) for all pairs of 52 major securities exchanges (large circles). Credit: Courtesy Wissner-Gross & Freer

The profit made on a stock share bought and sold a moment later might only be a penny or so, but if multiplied by millions of shares over the course of a day the money earned can be big.

High-frequency trades, characterized by short holding periods, now represent about 70 percent of all stock trades in the U.S. Even though most of these trades occur in the form of pulses racing down optical fibers, even this pace isn't fast enough for some people. Two Massachusetts Institute of Technology researchers in Cambridge have an idea about how to speed things up.

When an investor in New York decides to buy a stock on the New York Stock Exchange, it takes about 500 microseconds (millionths of a second) for the transaction to go through. Only a tiny portion of this "latency" is due to the time it takes light to travel from the computer issuing the "buy" order to the . Light travels up the length of Manhattan along Broadway in approximately one microsecond.

But what if your office were on the other side of the world, in Shanghai?

Then the travel time of light moving out across several optical fibers and racing around the globe would have to be figured in. In fact, the delay now would be at least 40 milliseconds (thousandths of a second), nearly 100 times longer than for the investor in New York.

The rapid buying and selling of securities by exploiting momentary price differences in far flung markets is called arbitrage. If, for example, some traders are buying shares of a company for $100 in New York and other traders are selling shares of the same company for 98 in Shanghai, then an agile middleman could snap up shares in one place and sell them in the other. The process is relatively low-risk unless prices change unexpectedly or a competitor beats you to the sale. To maintain an edge over other traders, it is crucial to be able to deliver information as fast as possible.

The latency disadvantage of globally distributed markets can't be entirely erased by technology, but the comparative lag times for international stock trades in general can be lessened by employing intermediate trading points. Alex Wissner-Gross, a physicist at the MIT Media Laboratory and Cameron Freer, a mathematician now at the University of Hawaii, propose to blanket the world with computer stations positioned along the paths between all of the major stock markets.

Securities trading companies could put semiautonomous computers at these strategic crossroads. Programmed with sophisticated buying and selling instructions these computers would act much more promptly to price signals coming from remote markets than if the signals had to travel all the way to the home office.

Wissner-Gross explains his proposal with the following analogy. If you accidentally touch a hot burner, a nerve signal goes not directly to the brain but to the spinal cord, where the sensory information "burn" can be processed more quickly, triggering a faster motor response; a muscle is commanded to retract the finger. Later the brain is notified of the whole episode, but when speed really counted, it was the lower-level part of the nervous system that issued the command.

This, according to Wissner-Gross, is analogous to what the proposed computer network would do. Indeed, he sees this kind of practical development as one more technological step in the human race's effort to "blanket the planet with computers, covering the world with a fabric of intelligent sensors."

Another expert on high frequency trades, Jonathan Brogaard of Northwestern University near Chicago, believes that the proposed computer network will help differing prices come to equilibrium more quickly.

"Wissner Gross and Freer have proposed a network and developed a technique for traders to determine the optimal geographical location to process information coming from multiple exchanges," Brogaard said. "It also helps to ensure faster convergence of prices, making the law of one price, a fundamental principle for the pricing of assets, hold at even smaller time increments."

Faster technology has long been a part of stock transactions. In the early 19th century carrier pigeons brought the fastest information about any kind of breaking news that could affect stock prices. Later came telegraph and telephone networks. Then computers speeded up transactions in a big way.

A recent example is the dedicated fiber optical line built between New York and Chicago. According to Forbes Magazine, the fiber -- 825 miles long if measured by distance or 13.3 milliseconds by the clock -- improved the between those cities by 3 milliseconds, enough to justify the cost of running the fiber.

The hundreds of computers linking the financial markets would speed things up.

"But the main reason behind the network would be to bring geographically separated prices more rapidly into equilibrium," said Freer. "We are currently talking with financial firms about licensing our technology for implementation on existing networks. In the longer term, new networks and computers could be deployed by exchanges, brokerages, etc., much like the current infrastructure in financial hubs."

The new results appeared in the Nov. 5 issue of the journal Physical Review E.

Explore further: New study refines biological evolution model

More information: Relativistic statistical arbitrage, A. D. Wissner-Gross and C. E. Freer, Phys. Rev. E 82, 056104 (2010). DOI:10.1103/PhysRevE.82.056104

Provided by Inside Science News Service

3.3 /5 (15 votes)

Related Stories

Wall Street's super traders come under fire

Sep 09, 2010

A handful of traders who master stock markets using ultra-fast computers may soon face a clampdown by US watchdogs as they try to prevent freak electronic glitches.

Traders Who Sell Short Stocks Are Well-Informed

Apr 03, 2008

The term “short selling” refers to the practice of selling shares the seller does not own, in the hope of repurchasing them later at a lower price. A new study in The Journal of Finance reveals that there is a large ...

Artificial Intelligence to tackle rogue traders

Apr 09, 2009

As the Credit Crunch continues to affect the worldwide markets the need for efficient methods to combat financial fraud has become more important than ever. Now researchers at the University of Sunderland are working on ...

Facebook splits stock 5 for 1

Oct 01, 2010

(AP) -- Facebook, the world's largest online social network, said Friday it is splitting its shares five for one, so that it can give larger stock grants to current and prospective employees.

Recommended for you

A new multi-bit 'spin' for MRAM storage

16 hours ago

Interest in magnetic random access memory (MRAM) is escalating, thanks to demand for fast, low-cost, nonvolatile, low-consumption, secure memory devices. MRAM, which relies on manipulating the magnetization ...

New study refines biological evolution model

Jul 21, 2014

Models for the evolution of life are now being developed to try and clarify the long term dynamics of an evolving system of species. Specifically, a recent model proposed by Petri Kärenlampi from the University ...

User comments : 14

Adjust slider to filter visible comments by rank

Display comments: newest first

Decimatus
4 / 5 (1) Nov 13, 2010
If a trader misses his trade by 35 milliseconds, he needs to hit the First Person Shooter Gym and train his clicky finger to move faster.

KwasniczJ
2.5 / 5 (16) Nov 13, 2010
Such fast trading is required only by automatized broker systems dealing with junk bond market, which was the reason of the stock market crash that occurred on Friday, October 13, 1989, for example. When bursa uses the it's own stock market prices as the main source of informations for transactions, it becomes implicit and unstable - no matter how fast its trading actually is.
Sanescience
5 / 5 (8) Nov 13, 2010
The automation implied in this article is only accessible to institutions, not typical investors.

Rapid automated trading automatons basically siphon off money from the market such that the stock market is basically just wealth transfer to these systems and has no place in the use of capitol to actually create wealth (economic activity) and will "Poison the well" if not stopped.
genastropsychicallst
1 / 5 (9) Nov 13, 2010
The speed of light is a special theory because nobody can be end-of-lightspeed-machiner as common practum and anybody aint quadrater then science/fiction.
jsn3604
5 / 5 (8) Nov 13, 2010
Perhaps those people should get more productive jobs. I definitely don't support millions in research so somebody can make their "gambling" career more efficient. "Buy and sell moments later?" Thats called gambling.
Skeptic_Heretic
5 / 5 (7) Nov 13, 2010
Our global economic system is ridiculous.

I predict that if human economics, as they are now, exist for another thousand years, we'll decore the Earth and replace the inside with a stock exchange so everyone gets fair trade times.

mondoblu
4.4 / 5 (10) Nov 13, 2010
Stock exchange should be put out of law!

In this century the major financial crisis were caused by speculative bubbles, not by some flu pandemic or lack of material/food.
SkiSci
3 / 5 (2) Nov 13, 2010
Stock exchange should be put out of law!

In this century the major financial crisis were caused by speculative bubbles, not by some flu pandemic or lack of material/food.


You're so right. We should all love each other and exchange dutch tulips bought on pets.com
wwqq
5 / 5 (2) Nov 14, 2010
The HFT arms-race is pointless and potentially dangerous(see the flash crash, which was _not_ caused by a missplaced keystroke).

The easiest way to de-claw HFT is to enforce a random latency of a second or two before your order goes through.
wolfkeeper
not rated yet Nov 14, 2010
There's no real business-related trading that takes milliseconds.

This is purely and simply a way to make cheap profits. It's not about lending money to businesses, it's a form of profiteering.

It's not profiteering where they raise prices by a large amount, it's done by small percentages.

They don't need to put faster systems in place, they need to enforce slower trading patterns.
fujiyama
not rated yet Nov 14, 2010
There is NOTHING anyone can do to make transactions flow to the stock exchange faster than the speed of light. It is a fundamental law of physics
El_Nose
not rated yet Nov 15, 2010
@ fujiyamma obviously -- an no one tried to imply that

@everyone else

High frequency trading does make a little bit of money for those that are good enough to write programs that can catch these fractions of a penny differences.

But what you do not understand is that this has been done for years just at a slower pace.. its called arbitrage and its a good thing for the markets. It means the price people get in the market are good prices... they have been adjusted for information and systems that are too slow are getting gamed .. and that is a very good thing. These high frequency people provide liquidity in the market these are two of the most important factors of any market -- liduidity and price effeciency.

@wwqq many

dark pools do use a random latency to for anti-gaming such as POSIT.

But getting into HFT is difficult - you need to really understand the market and know how to program very well... and be physically close to the exchange.
A_Paradox
not rated yet Nov 15, 2010
el_nose,

surely liquidity comes from banks creating money as loan accounts. Maybe arbitrage has an effect of making things a bit more fluid but ultimately it has to be just another form of parasitism, and I think it must contribute to instability sometimes.
xznofile
not rated yet Nov 20, 2010
sounds like trading is in for a hit, what will be the effect when geographically separated prices are brought so rapidly into equilibrium that there's no difference between markets? except maybe faster and faster automated responses to femtosecond differences? I see a brick wall ahead.