NEW YORK (Reuters) - Inside the offices of Tradeworx, an emerging player in the secretive and controversial world of high-frequency

trading, it's dead quiet as staffers pore over the "tape," financial industry speak for the record of the day's transactions.
Who's afraid of high-frequency trading?
Many of the firm's 30 employees are not yet 25. They were hired straight from college to ensure their thinking and work habits are untainted. Now they're making Wall Street's latest fortune, a fraction of a penny at a time. The only clue that Tradeworx, a six-year-old hedge fund based in Red Bank, New Jersey, is a financial outfit at all are two giant screens that break up the monotony of white walls and grayish carpets. The physics and computer science graduates are crafting complex computer codes to exploit trading patterns revealed by the tape. Tradeworx and other firms like it use such algorithms in the lightning-quick trading approach that is altering the landscape of U.S. markets, driving broker-dealers out of business and changing how money managers invest. High-frequency trading now accounts for 60 percent of total U.S. equity volume, and is spreading overseas and into other markets. These traders stand ready to buy and sell shares at all times, providing the liquidity that keeps markets moving. As a result, trading is now cheaper and easier than ever. Yet critics worry fast trading may undermine the integrity of the U.S. equity market, a bastion of capitalism and corporate America, and could even spark another financial crisis. They also complain about the money high-frequency firms are making -- and how they are making it. During last year's plunge, when volatility rose, many high-frequency traders earned 10 times their usual profits, executives at several of the proprietary firms told Reuters. For their part, the fast traders don't see what all the fuss is about. "We live in a capitalist society," said Tradeworx Chief Executive Manoj Narang, 40, wearing jeans, runners and a Yankees baseball cap. "People should expect and be willing to pay a price for the liquidity that they get. No one should expect that a provider of liquidity is just going to stand there while you bulldoze them into submission," Narang said. Tradeworx started high-frequency trading in January and now accounts for about 3 percent of overall volume in the exchange-traded fund SPDR Trust, which tracks the Standard & Poor's 500 Index and is one of the most heavily traded securities. High-frequency traders point to last year's steep sell-off as proof of their value in helping the market run smoothly. While over-the-counter and other markets seized up, exacerbating the worst financial crisis since the Great Depression, fast traders continued to buy and sell shares. Proponents also laud computerized trading for eliminating the shady transactions that often occurred in the past when people were directly involved in trading. TAPE HOLDS ANSWERS TO DEBATE Trading today seems less intimate, less human, married as it is to computer code. The revolution has caught some people off guard, and has led to deep concerns.

Many institutional money managers are uneasy about how the fast traders anticipate their transactions, and worry that there might be information leakage about their trading intentions -- a critical issue for asset managers. "High-frequency trading, fundamentally, when you look at what their algorithms are finding, they're almost a structured way of trying to front-run," said Jim McCaughan, chief executive of the asset management arm of Principal Financial Group, where he oversees about $215 billion in assets. "That just seems to me ultimately as doing it at the expense of other investors," he said. McCaughan said he had no proof of wrongdoing, yet he suspected it is quite likely the leaking of information may have happened. "If it has, it would at best be unfair to other investors and perhaps criminal," he said. A furor over the extent of computerized trading erupted this summer when news of the enormous profits being garnered rankled a public already apprehensive about a crisis rooted in Wall Street -whose bailout the taxpayer is footing. Critics fear an errant computer code, similar to the program trading behind the Black Monday crash of 1987, could engender another deep market plunge. The U.S. Securities and Exchange Commission is taking months to investigate all this. With highfrequency trading spreading quickly from its U.S. equity base, the regulator's response will be crucial for capital markets around the world. Key to any discussion of high-frequency trading is the tape, which records the price, time, size and order of trades. It's the day's financial narrative, and its availability is held up as a major reason why the U.S. equity markets are trusted for their transparency and fairness. The tape is also highly prized by traders, who base their computer instructions, called algorithms, on this data. The Nasdaq Stock Market produces about 50 gigabytes of information every day, which is measured in nanoseconds -- or a billionth of a second. Lotus Capital Management LP of New York earlier this year realized that a competitor was beating it to a trade it had programed by exactly 3 microseconds, day after day. The loss meant Lotus was forfeiting about $1,000 in daily revenue on that particular trading strategy. Lotus, a quantitative trading firm that uses high-frequency strategies, invested and tinkered, eventually shaving five microseconds from the router and two microseconds from the execution server. "By just reading the tape you can see a lot of what the other guys are doing. You can see who is successful. So eventually everyone is operating more or less the same strategy," said Louis Liu, the 37-year-old founder of Lotus. BROKER-DEALER MODEL UNDER FIRE Operators like Lotus have changed the nature of the business. Small start-ups can launch with less than $1 million, and are creating enormous cost pressures on established broker-dealers and others that can't keep up, Liu said. "That's where a lot of the complaints are coming from. We're driving the spreads down and squeezing the profit margins," he said. Legacy operators know what needs to be done, "but they're not willing to cannibalize their existing business," he added. Being nimble is key to success. Narang said he and his partners at Tradeworx realized a couple of years ago that high-frequency traders were "eating the lunch" of its hedge fund business. In response, Narang moved into fast trading and incorporated those techniques in the hedge fund.

The firm began targeting math whizzes very selectively. Last year, just six of 1,500 resumes led to jobs at Tradeworx, one of several firms setting up shop in up-and-coming Red Bank, a former manufacturing hub. Others agree with Liu that the recent cries of foul play and other criticisms of electronic trading are coming from those who have been displaced in the lucrative brokerage business. "The broker-dealer business model is dying, and you have massive over-capacity," said Harold Bradley, chief investment officer at the Ewing Marion Kauffman Foundation in Kansas City, where he oversees $1.7 billion in assets. "You don't need a dealer to put you and me together through three other brokers in a Nasdaq stock. There should be fewer people in the business." Several incidents this summer underscored the secrecy and money to be made from high-frequency trading. The FBI in July arrested a former Goldman Sachs Group Inc (GS.N) computer programer for allegedly stealing trade secrets. The bank later reported blowout second-quarter earnings, bolstered by $10.78 billion in trading income. When TABB Group estimated $21.8 billion was earned annually in high-frequency trading, the media pounced on the issue. Yet few critics asked how the size of profit compared to the past. Rosenblatt Securities pointed out that as far back as 1997, overall trading on the Nasdaq alone may have generated $20 billion in annual brokerage revenue, suggesting that profits were already substantial more than a decade ago. REGULATOR'S REPORT LOOMS Proprietary trading powerhouses Getco and Tradebot, hedge fund Citadel Investment Group and trading desks at Goldman Sachs and Citigroup Inc (C.N) are some of the industry's prominent names. Tradebot and Getco, seen as trailblazers in rapid trading, regularly account for a combined 20 percent of the overall U.S. stock market. Market sources suggest the firms each trade more than 1 billion shares a day. Tradeworx trades some 80 million shares per day. With worries over systemic risk growing, the SEC has jumped into the fray. It has proposed a ban on so-called flash orders and wants to crack down on the scores of anonymous trading venues known as dark pools. The regulator plans to issue a report early next year that officials said would focus on whether markets reliant on high-frequency trading are more or less efficient for long-term investors, including those trading small- and mid-cap stocks. Most fears of a blow-up surround what is known as naked sponsored access, in which brokers allow traders use of their identification to directly trade on exchanges, saving the traders valuable time. Critics also say the fast traders are less willing to take the other side of trades outside of large-cap stocks, reducing the amount of liquidity in smaller companies. Politicians also are stirring the pot. Senator Ted Kaufman has warned high-frequency trading could lead to market chaos and systemic risk. In October, SEC Chairman Mary Schapiro told Reuters the regulator "will not hesitate to propose regulatory approaches" if concerns are "significant. The SEC recently hired Richard Bookstaber, a well-known former risk manager at Morgan Stanley (MS.N), Salomon Brothers and hedge fund Moore Capital Management, to work in a newly created division designed to identify risks in financial markets.

Bookstaber indicated on his blog in August that he is not particularly worried that high-frequency trading or the use of algorithms will lead to a blow-up. "I don't think the risk is as big as many are making it out to be," he wrote. Institutional investors mostly complain about alleged unfair advantages and that their trades are being "gamed." A high cancellation rate for orders has sparked suggestions that the algorithms are deployed to glean information from pending order flows, and then based on that knowledge, race ahead to scoop up trades. More than 90 percent of orders submitted to the New York Stock Exchange by high-frequency firms are canceled, according to an NYSE Euronext (NYX.N) official. Overall, the average daily trade volume of NYSE-listed stocks has more than tripled in five years as of 2008. The head trader of a European money manager with more than $100 billion in assets said highfrequency traders profit through pattern recognition software to anticipate a trade. "It's a certain knowledge of what's coming. It's not like they're guessing what's going to happen, they're not speculating," said the trader, who spoke on the condition of anonymity. And he added emphatically: "They know." Detractors also question the amount of money the high-speed traders make, especially after holding a stock for only a few seconds. They wonder what purpose such quick turnover serves. The market "is not trading on fundamentals anymore. It makes no sense, it's very frustrating for traders," said Alan Valdes, director of floor trading at NYSE member Kabrik Trading. "It's all programs." 'NO BARRIER TO ENTRY' The criticism has frustrated high-frequency traders, who are increasingly going public to defend their business. Several said they expect little impact from any new regulation, and expressed confidence that their role in the marketplace would be preserved. Fast traders are proud they make their money through a battle of wits, believe in the work ethic and do not rely on chummy business ties. There is talk of forming an association, presumably to quell complaints and educate the public about their business. "If you were on Wall Street in the 1990s ... you would need to take guys out to dinner and build relationships, otherwise you couldn't get at the order flow. And now, if you're good ... there's no barrier to entry," said Cameron Smith, general counsel at Houston-based technology and trading firm Quantlab Financial LLC, which does high-frequency trading. "That is a really incredible improvement to the Wall Street environment," he said. "That's how we want markets to work." A sign of the critical role the fast traders have assumed came to the fore last year after the SEC briefly banned the short-selling of financial securities. Spreads widened and trading volume declined as high-frequency traders cut back on their presence to adjust algorithms. After the ban was lifted, the high-frequency players came back. Spreads started collapsing and volume picked up, said Todd Mackedanz, head trader at Fisher Investments, the firm founded by billionaire investor Ken Fisher based in Woodside, California. "With that said, they do in a sense play a fairly important role in the marketplace," Mackedanz said. Fisher Investments, like other institutional investors, has set tight price limits and is careful about whom it trades with to try to ensure it gets the best execution possible.

Many investors fear that high-frequency trading may fall prey to bad habits. In 1994, for instance, an academic study found that a large number of Nasdaq stocks were traded with spreads that were double the minimum, raising the question of whether dealers colluded to maintain wide spreads. Jean-Marie Eveillard, a legendary investor on Wall Street, said that high-frequency trading strikes him as suspect. But Eveillard said in an e-mail message that he had no particular insight other than this: "If in a good mood, I say Wall Street is nothing but a vast promotion machine. If not, it's a den of thieves. So there is always the possibility of front running, insider trading, market manipulation." HIGH FREQUENCY TRADING STRATEGIES Any big market move creates ripples on which high-frequency traders feast. Correlation strategies -- like selling the S&P 500 index exchange traded fund when a blue-chip company misses earnings expectations -- are left to high-frequency players with the most horsepower. Others are relegated to more complicated techniques, poring over historic trading records in various regions and asset classes. Market making is the dominant technique, with the top-tier "ultra high-frequency" firms -- those trading more than 1 billion shares per day and holding positions for seconds -- relying heavily on gathering the rebates exchanges pay them for posting orders. If a trader's bid of $15.80 for Bank of America (BAC.N) shares is matched, that person might immediately post an offer for the same price, hoping to capture two rebates while breaking even on the spread. The result, according to several independent proprietary firms, is a flooding of the 50 some U.S. trading venues with orders, and near-immediate execution for investors -- even if the high-frequency trader on the other side of the trade walks away with one-tenth of a penny per share, on average. A misunderstood dynamic of high-frequency trading is that it thrives off volatility, thereby reducing it. The clear winners in the revolution are small investors, who have seen their trading costs fall remarkably and markets price shares far more efficiently. "Most of our clients really don't spend a lot of energy worrying about the last penny on a trade, or the last two pennies," Charles Schwab, founder of Charles Schwab Corp (SCHW.O), the largest U.S. discount brokerage, said last month during a Web cast business update. "We think the liquidity components are perfectly satisfactory." SECRECY AND SUCCESS The 2000 decision to price quotes in decimals of a dollar was probably the most important in a series of U.S. rule changes in the last dozen years that sowed the seeds of high-frequency trading. A spread of 25 cents for a Nasdaq stock was not uncommon 15 years ago, when market makers and floor specialists had fixed commissions and wooed clients to win business. The late 1990s introduction of alternative trading venues was another regulatory turning point, as well as a 2005 "trade-through" rule that ensured investors get the best U.S. bid or offer, no matter where it was. Transactions are dramatically faster, and the duration of time long-term investors own securities has been shortened. Eighteen months is now considered very long, compared with two or three years about half a decade ago. Another complaint that haunts high-frequency trading is secrecy -- not just around their firms' strategies but even who they are. A number of firms declined to be interviewed by Reuters.

"People think that high-frequency trading firms ... are secretive because they're doing something untoward," Narang said. "Really the reason they're secretive is because as soon as they spill the beans other people can compete with what they're doing." All Wall Street firms want to stay under the radar screen, said Robert Olman, president of Alpha Search Advisory Partners, an executive search firm for hedge funds and prop shops. "Once you're successful, once you have a system that's making money, you become very secretive because it's very easy for one of your guys to leave and replicate it," he said. That's the reason behind Coca-Cola Co's closely guarded formula for making Coke, he said. "What are the exact ingredients and proportions of Coca-Cola? Is there something wrong going on at Coca-Cola?" he said. "That's the point. It's replication, ease of replication. The barriers to entry, to competing, are not too high."

FACTBOX: A modern trader's clock: Micro, nano and picoseconds

TORONTO (Reuters) - Trading a stock is now far faster than a blink of an eye or the speed of a lightning strike, and in the race to shave time, high-frequency traders are ramping up technology to get closer to the speed of light.
Key to high-frequency trading is latency, industry jargon for delays that occur in transmitting buy and sell orders. Also important is throughput, a measure of how much data can be transferred over a period of time. Lower latency and better throughput mean faster trading. However, latency is never constant, said Donal Byrne, chief executive of Dublin-based Corvil, a supplier of latency management systems for high-frequency traders. Like the weather, it's always changing and variables such as distance, traffic load, bandwidth and processing capacity can slow a trade, Byrne said. High-frequency trading now revolves around microseconds and even nanoseconds. Picoseconds are on the horizon. WHAT'S IN A SECOND? 1 millisecond (ms) = one thousandth of a second 1 microsecond (us) = one millionth of a second 1 nanosecond (ns) = one billionth of second 1 picosecond (ps) = one-trillionth of a second *** A fast trader can type and submit perhaps five trades in a minute, said Paul Michaud, a trading and risk management specialist at the software group of International Business Machines Corp in Houston. In those 60 seconds, exchange systems and black boxes will soon be able to transmit 60 million trades, he said. "Generally people view we're in a race to zero here. I mean literally we're in a race to zero. Speed of light is actually an issue for a lot of our clients," Michaud said. ***

"An electrical signal can travel down a wire 200 meters in one microsecond," said Greg Allen, vice president of governance, architecture and planning at TMX Group Inc, parent of the Toronto Stock Exchange. *** "A blink of the eye is about 200 milliseconds," Allen said. "The fastest exchange or ATS (alternative trading system) would've been in the range of 5 milliseconds," referring to trading venues built up to five years ago. "Now, the best ones claim to be around 500 microseconds -- so half a millisecond." *** "(Lightning) goes about 120 meters in a millisecond. In that same millisecond your order can travel about 200 kilometers," Allen said. *** The speed of light, at 300,000 kilometers per second, remains elusive. "Unfortunately it is not possible to exceed the speed of light as much as Wall Street might like to," said Michaud. "It takes you about half a second to click a mouse. The new exchanges are being designed to do a million trades in the amount of time it'll take to click a mouse," he said.

Thomson Reuters Launches Machine Readable News Service

Thomson Reuters has launched a new service that will provide high frequency traders in London and Chicago fast access to market-moving machine readable news content, the company said today. The service, NewsScope Direct, will offer microsecond delivery of highly structured news and economic data, which will enable clients to buy and sell financial instruments before the information moves the market. Housed in Thomson Reuters London and Chicago hosting centers, NewsScope Direct allows clients to incorporate news and events into a variety of trading strategies. Customers can connect to the newsfeed from their own data centers or leverage Thomson Reuters proximity hosting solution. This will benefit high frequency trading firms operating in the FX and Futures markets which can move sharply in response to key news and economic data, noted the company. Rich Brown, global business manager of machine readable news at Thomson Reuters, said the launch of NewsScope Direct into London and Chicago reflects our commitment to delivering the market moving information our clients need at the speed required by their high performance trading strategies. Todays launch is an expansion of the service available to clients in New York and the companys beta site operating in Washington, D.C.

High-frequency trading surges across the globe

NEW YORK/TORONTO (Reuters) - High-frequency stock trading is spreading around the world into more and more asset classes, but progress is being slowed by poor infrastructure, heavy regulation and opposition from entrenched interests.
In some major markets in Asia, it can take seconds to execute an equities order. That's a lifetime for a trader who uses sophisticated algorithms to trade thousands of shares in a millisecond with the aim of earning a profit from market making and price imbalances. Turf battles between exchanges also sometimes prevent the kind of interconnected market approach that provides fertile ground for high-frequency trading. Traditional brokers and institutions, whose positions are threatened by upstart trading houses, also help to erect barriers. But the high-frequency wave, estimated to be responsible for about 60 percent of U.S. stock trading, has already washed over much of Europe and is being felt in some emerging markets, particularly in Latin America. It is also making inroads in futures, options and foreign exchange. In Brazilian stocks, there are signs that high-frequency trading is starting to get a grip, and some relatively small markets like Mexico and Colombia are encouraging major U.S. trading firms to bring in their latest rapid-fire trading techniques. Smaller markets are attracted by the promise of more liquidity, which can make investing and trading cheaper and easier for everyone and help those who want to raise capital. Concerns about algos gone wild setting off a market panic are secondary. "It's a virtuous circle. The more people come, the more other people want to come," said Martin Piszel, head of alternative execution services at CIBC World Markets, the investment banking arm of Canadian Imperial Bank of Commerce. PATCHWORK OF REGULATION In some European stock markets, high-frequency trading is already responsible for more than a third of all trading, according to several estimates. The electronic wave has dramatically narrowed spreads and driven down trading costs, opening up some markets like never before. Still, Asia, while having a lot of potential, is far behind. "The regulatory environment in the U.S. and Europe, which is geared toward best execution, does not exist in Asia," said Takayuki Saito, head of direct execution sales at UBS AG's Asia-Pacific division. Rule changes in the United States and Europe have harmonized trading and sparked a price war among exchanges and alternative venues. But such changes are a long way off in Asia, where spotty liquidity and patchwork regulation are long-standing problems. Also, most of the region's markets don't yet have the infrastructure to handle trading firms that use microseconds -- or a millionth of a second -- to measure the time it takes orders to reach markets. "The systems in Tokyo and Hong Kong are very slow. It takes several seconds for the exchange to accept a trade," said Neil Katkov, senior vice president and head of Asia at financial consultancy Celent. "There are only a few that operate below the one-second mark, like Korea."

Much may hinge on a plan by the Tokyo Stock Exchange to launch in January a new trading system that has an order response system of 10 milliseconds or less, he said. UBS estimates that about 30 percent of Japanese equity trading is high-frequency. That compares with up to 10 percent in all of Asia, up to 10 percent in Brazil, about 20 percent in Canada, and up to 40 percent in Europe, according to a report by New York-based agency broker Rosenblatt Securities. High-frequency trading accounts for up to 40 percent of trading volume in U.S. futures, up to 20 percent in U.S. options, and 10 percent in foreign exchange, the report said. Traders and analysts said fixed income and commodities are also considered ripe for growth -- although it may come with a fight. "The dealers put up a really good fight to try to keep the new breed of electronic liquidity providers out, and keep a tight-knit club on who can make markets" in over-the-counter foreign exchange, said Richard Gorelick, CEO and co-founder of high-frequency trading firm RGM Advisors LLC in Austin, Texas. "Gradually, it's become a market that's a lot more open to diverse market participants," he said. TAKING HOLD IN BRAZIL The real bonanza could come as U.S. and European politicians and regulators push more of the world's derivatives onto transparent exchanges, a change intended to avoid a repeat of the blowups that led to last year's financial crisis. While fragmentation poses problems in Asia, high-frequency trading has taken hold in Brazil, due in large part to exchange operator BM&FBovespa, which has a virtual monopoly on stock trading in Latin America's largest economy. Trading has boomed at the exchange since August 2008, when it began offering so-called direct market access (DMA) to companies looking to quickly implement algorithmic and high-frequency strategies. Marcio Castro, the exchange's director of information technology and trading systems, told Reuters the exchange sees "huge potential" for growth and plans to double trading volume capacity in 2010 to accommodate the high-frequency surge. Last month, UBS launched algo trading for non-Brazilian investors wanting to trade on BM&FBovespa, whose benchmark index jumped more than 70 percent this year. Bank of America Corp in October began offering a platform for Brazil-based algo traders, adding to similar services in India, Malaysia, Thailand and Singapore. The bank is also eyeing Mexico, where the regulator plans a market overhaul intended to attract high-frequency traders. TORONTO BATTLES "MYTHS" In Canada, alternative venues have bloomed in the past few years, leading to more competition for orders. More recently, it has led to a rush of traders seeking rebates the venues offer for trading there. TMX Group Inc, which runs the Toronto Stock Exchange and Canada's main derivatives market, has been fighting back with more aggressive pricing meant to attract the fast traders -- but it struck a measured tone on the evolving markets. "One of the myths that we want to overcome is that high-frequency trading is everything to the future. It is a vital component, but the traditional players also have a role in the marketplace," Rob Fotheringham, senior vice president of trading with TSX Markets, said at a Toronto conference.

Paul Wilmott, a leading expert in quantitative finance, said high-frequency trading could be bad for markets. "We should stop and think before we go too far down that route, simply because when a lot of people are following the same strategies then you get the potential ... for bubbles and crashes, which we don't want," he told Reuters. The debate has been amplified this year in the U.S. options market, seen as one of the most obvious targets for the high-frequency firms. Options and equities share the same big investors, regulators and exchange operators. "That's probably the next battleground. But it will probably take a couple years to finalize the structure," said Louis Liu, founder of quantitative trading firm Lotus Capital Management LP, which uses high-frequency strategies. ONE TRADER LEADS TO ANOTHER In stocks, even smaller emerging markets see an opportunity to get a lot more liquidity if they make themselves friendly to high-frequency traders. "We tried to talk to people in Chicago and New York, but attracting their attention when they still have all the Asian market to conquer and some of the European market, looking at Colombia is still small," Juan Pablo Cordoba, president of the Colombia Stock Exchange, said at an event in New York. "The big question is what can we do to attract one, because if we attract one, maybe we can attract three or four international players. That is a big challenge."

New Device Switches Traffic In Less Than 100 Billionths of a Second

Voltaire Ltd. is hoping to attract the attention of high-frequency trading firms with the launch of a new communications device it claims can switch traffic between servers in less than 100 billionths of a second. The Chelmsford, Mass., company also says its hybrid switch and network gateway can move traffic between Ethernet-based networks at less than two thousandths of a second. The speeds should help reduce total trade execution times and other trading firm processes, Voltaire asserts. The company, which is also headquartered in Raanana, Israel, says the combination product is designed to take up only 1.75 vertical inches of data center rack space rather than comparable technology that can take twice as much space. This helps reduce co-location costs. The Grid Director 4036E combines the power of a 40-Gigabyte InfiniBand switch with a low-latency Ethernet gateway that can bridge traffic to and from Ethernet-based networks and takes the pain out of bridging from InfiniBand to Ethernet which is a much-needed capability in many high-performance, enterprise IT environments, according to Asaf Somekh, vice president of marketing at Voltaire. He believes the new product could be a game-changing solution for high-frequency trading firms, exchanges and trading venues that use large clusters of computers and need smooth, fast more traffic management between Ethernet-based networks. High frequency traders are looking with a magnifying glass at every step of the data delivery process from the moment data leaves the Exchange and then goes back with a trading order. And while we offer both Infiniband and 10Gigabyte Ethernet-based switches, its clear that Infiniband is the fastest technology and therefore, best for high-

frequency trading, Somekh insists port-to-port latency within the 4036E InfiniBand switch is less than 100 nanoseconds, or billionths of a second. The firm is a well known advocate for Infinibandbased switching technology, while some of its competitors -including Cisco Systems appear to have focused more energy on promoting purely 10G Ethernet-based switching devices. Voltaire devices are included in server and blade offerings from firms such as Hewlett-Packard, IBM, NEC, SGI and Sun Microsystems. Somekh also pointed out that in financial services, market data feeds typically run multicast traffic over 1 to 10 Gigabit Ethernet which the Grid Director 4036E significantly accelerates the transfer of multicast traffic coming from an Ethernet network onto an Infiniband network. Adam Honore, a senior analyst at Aite Group, said that for trading firms that do choose to employ Infiniband technology, the new product is an important development, particularly when using market data products over Ethernet hubs or when aiming to speed up and better integrate networks related to risk management and settlement efforts or anywhere where cross connect capabilities are important. However, he also pointed out that among trading firms at large not just high frequency, low latency traders -- there has been far broader interest in purely 10Gigabyte Ethernet technology rather than Infiniband. In a 2010 IT Spending Report issued by Aite Group in which 30 CIOs at trading firms were interviewed, 20% said they plan to upgrade to 10Gigabyte Ethernet technology while only 13% aim to upgrade to Infiniband. That said, 40% say they aim to upgrade their server technology. What remains to be seen is to what degree their server technology purchases in the months ahead may or may not incorporate Infiniband.

European markets' choice: Cut milliseconds or die

LONDON (Reuters) - Increasing demand for instantaneous trading is driving Europe's stock exchanges and other equities markets to spend heavily on technology to stay competitive -- and not all of the 33 players will survive.
Small venues that cannot attract enough liquidity or afford to keep up with rivals are likely to fall by the wayside or become niche venues dedicated to specialized domestic markets. "In the end, you are going to see three or four major execution venues account for close to 80 percent of all pan-European trading," said Sang Lee, managing partner specializing in market structure at consultants Aite Group. In Europe over the past 12 to 18 months, high-frequency trading has grown to account for an estimated 35 to 45 percent of all equity trades at the biggest venues. High-frequency traders use algorithmic, or automated, trading to seize on pricing anomalies, trends or events and execute trades instantly. The programs make many thousands of trades in a day, each of a modest size in a liquid stock to capture the intended price.

"The ability of high-frequency traders as a group to exercise buyer power and shape market infrastructure is massive," said Instinet Europe Chief Executive Richard Balarkas. Many exchange executives expect Europe to catch up with the United States, where Aite forecasts high-frequency trading will account for more than 70 percent of trades by year-end. But Lee said fast trading could stabilize in Europe at a lower share, partly because of the lack of the simpler, single post-trade clearing and settlement infrastructure of the U.S. market. London-based Chi-X Europe, which has become a major European trading venue even though it was only launched in 2007, has seen high-frequency trading hold steady at around 40 percent of its European trading activity for the past year and expects it to remain at about that level, said Chief Operating Officer Hirander Misra. "You do have firms out of the United States coming into this space and an increase in activity, but we are seeing an uptick in non-high-frequency trading as well," he said. "With any venue you need a mixture of players for the market to work." The rise in high-frequency trading in Europe came on the heels of European Union deregulation two years ago that opened up the exchanges to cross-border competition. "The increased competition has pushed the regulated market to invest heavily in technology and the software behind their order books," said Axel Pierron, senior analyst at consultancy Celent. LATENCY AND LOCATION A key way to measure the result is latency -- the time needed to send and receive trade information. "There has been a huge improvement in latency overall in the European cash equity markets," Pierron said. "It has evolved from a few seconds to milliseconds." Many big venues now measure latency in microseconds, or millionths of a second. Latency also depends on distance. Data takes about one millisecond to travel 100 kilometers (60 miles) on a fiber-optic network. That makes location vital. Exchanges offer co-location -- placing the client's computer adjacent to its own servers in its data centers -- to provide the quickest speeds. "London is emerging as the central place for high-frequency traders, and most of the order books are going to be located in London," Pierron said. NYSE Euronext is building a new data center in Basildon, a town near London, to host all its European business -- the NYSE Liffe derivatives business, the cash markets and co-location. "We wanted all of our markets to be centralized physically in one location," said Anthony Attia, senior vice president in charge of its Universal Trading Platform. The new site is also close to many of its biggest customers, not only high-frequency traders, he said. Its current primary centers in Paris and London will be maintained as disaster-recovery sites. Speed is essential for most players in equity markets, not just algorithmic traders, said several trade venue officials. Deutsche Boerse is keeping its Xetra data center in Frankfurt next to servers for Eurex, its derivatives exchange. At the same time, it upgraded the link with London, shaving off several milliseconds to below 5 milliseconds. And with Xetra International Market, it is starting a program to directly trade 96 blue chips from across the continent by mid-January.

Michael Krogmann, executive director of Xetra market development and sales, sees Deutsche Boerse making investments every year for the foreseeable future in data centers and software to continue improving speed, capacity and reliability. "It's never sufficient, of course," he said. "For customers that make a lot of money implementing arbitrage strategies, it's important to be just a microsecond faster than the other guys that might have a similar strategy." SIX Swiss Exchange's strategy includes lowering tariffs and finding other ways to reduce costs, as well as improving latency and capacity, said Chief Executive Christian Katz. Falling prices are encouraging clients to add connections across Europe, he said. "Many of the prop (proprietary) trading companies and banks that maybe had several servers at five co-locations across Europe, now may be able to afford more servers set up in over a dozen sites." As the competition heats up, "Europe is already being sorted into winners and losers," said Randy Williams, head of global communications for U.S.-based BATS, which launched its trading platform in Europe just about a year ago. Some venerable players have lost market share. The London Stock Exchange has seen its share in the FTSE 100 blue chips dip to near 50 percent from more than 80 percent a year ago. Another possibility could be the emergence of a two-tier market, with a few pan-European players and a second tier of smaller venues dedicated to specific domestic markets, Aite's Lee said. Still, competition on speed and pricing will eventually reach natural limits, Chi-X's Misra said. "Speed can't be a race to zero, and neither can trading tariffs." (Reporting by Jane Baird; additional reporting by Daisy Ku; editing by John Wallace)

BlueCrest spends big on rapid-trading "arms race"

LONDON (Reuters) - Buildings beside Buckingham Palace and in the unexceptional English town of Basildon are among the centers of a quiet revolution in European stock markets as trading firms and funds seek to boost lightning-fast trades by a few millionths of a second.
Basildon, near London, is where NYSE/EuroNext, which runs four European bourses, is setting up a huge new data center to cut out the milliseconds lost when trading orders cross the North Sea. And secretive hedge fund firm BlueCrest is running some of the "black boxes" it uses for automated trading in screen-filled trading offices once used by Enron, overlooking Buckingham Palace gardens in London. It also has another data center south of the River Thames. With assets under management of about $15 billion, of which around 60 percent is in its black box systematic trading strategies, BlueCrest relies on powerful computers that run programs designed by a small army of PhDs from among its 300-plus UK-based employees. BlueCrest, Europe's third-biggest hedge fund firm and one of the biggest names in the area of highfrequency trading, has been one of the winners during the credit crisis with strong fund performance,

helped by trading technology it built itself and infrastructure it compares to that of an investment bank. In an indication of how important the computers are to its business, some are given nicknames. One is known as "ET," a title it earned because it got trapped for some time in a Japanese data center after the collapse of the investment bank Lehman Brothers. They can issue orders for tens of thousands of trades a day, set off by triggers in the software. Dipping into the market in fractions of a second, they pull in many tiny gains from short-lived price differences until they create solid profits. "There's an arms race going on -- what took 10 milliseconds now takes 10 microseconds. The space between the algorithms and the exchange is reducing year on year," Mark Holt, BlueCrest's technology commander-in-chief, said in a rare interview. "The fastest we could get is running on the same server as the exchanges' matching engine." To that end, European stock exchanges now offer space in their data rooms, with hedge funds paying to be only a cable's length away from the source, stripping out tiny time lags as the data zips across the City. High-frequency trading has been estimated to account for about 60 percent of equity market volume in the United States, and in Europe some estimates suggest it has already reached as much as 45 percent in some venues. The high-frequency trading programs designed by BlueCrest's physicists, mathematicians and computer scientists, aim to make money from minuscule and short-lived pricing blips. Headed up by Leda Braga, widely regarded as one of the most successful women in London's hedge fund industry, its system trades stocks or baskets of stocks and futures that have moved outside their historical patterns. Such a pattern can be a stock's historical behavior relative to other stocks or its typical response to an earnings announcement. TOO FAST BlueCrest, 25 percent-owned by the world's biggest listed hedge fund company, Man Group, was set up by former JPMorgan traders Mike Platt and William Reeves in 2000. They are said to have formulated the plans in Reeves's kitchen. Camera-shy Platt, ranked joint 222nd in the Sunday Times rich list with an estimated wealth of 250 million pounds and now sole CEO after Reeves stepped back from day-to-day running of the firm, does not limit his interests to the world of statistics and technology. In his spare time he is patron of All Visual Arts, a foundation that funds artists. Exhibits have included a Swarovski crystal skull, an apparently levitating model head of John the Baptist, a Japanese woman riding a walrus, a controversial, life-like black Christ in an electric chair, and a wooden replica of a Second World War V2 rocket. However, rocket power is not precisely what BlueCrest is aiming for with its systematic trading -- it is looking to be smarter rather than faster. It puts money into the signal analysis and market predictions that feed the strategies programed into the "black box." No sense being fast, after all, if your strategy is flawed. "If the algorithm takes a number of milliseconds to run, then microseconds don't help," says Holt. "The model decides if the market's moving toward us -- in which case we'll place orders further away because we believe we'll get a better price -- or away from us, in which case we want to trade faster," Holt said.

The group does not plan to move its black boxes to the stock exchange, as access will likely be reserved for member firms. BlueCrest trades either by using a broker's exchange membership or by using brokers' own trading systems, which themselves are getting faster and faster. Instead, it is spending big on its staff to make smarter trading software, not faster computers. Still, the black boxes are its most valuable assets. "If you look at the systematic business, technology is by far the biggest item of operating expense," Holt said. He would not give details of the costs. MAKE MONEY BlueCrest came through the financial crisis looking strong -- the dollar version of its fund is up 38.04 percent in the 12 months to the end of September. But it is far from alone in the high-frequency game in Europe. A growing number of traders are leaving banks to set up their own, small-scale high-frequency trading businesses, dealing in sums as small as $1 million or $2 million, said Martin Cornish, at law firm Katten Muchin Rosenman Cornish. "We're seeing some teams leaving large banks, investment banks, even hedge funds, and setting up proprietary trading businesses. They want their own businesses," he said. Setting up small-scale shops is attractive to traders because they can avoid having to get authorization from the UK's Financial Services Authority, meaning they can gain super-fast access to exchanges without having to hold regulatory capital. Investors are shifting as well. HSBC Alternative Investments has doubled exposure to statistical arbitrage funds with ultra-fast technology to around 5 percent by investing in GLC Gestalt, a long-standing London-based fund headed by Lawrence Staden. Many of these funds are offering good investment opportunities, says HSBC's Tim Gascoigne, because the downturn in the last year has wiped out many players. "A lot of capital has left the space. A fraction of the capital is chasing these arbitrage opportunities," Gascoigne told Reuters in an interview.

Regulators ask if faster is better on Wall Street

NEW YORK/WASHINGTON (Reuters) - Alarm bells are ringing in Washington amid a sudden realization that lightning-fast computer programs and anonymous venues are dominating trading on U.S. equity markets. But it may not be quite as scary as some suggest.
After being asleep at the wheel in the run-up to the financial crisis and throughout Bernard Madoff's Ponzi scheme, U.S. regulators and lawmakers are understandably keen to be seen peering into the dark corners of the financial markets. "We just know from history, in every single case if you have a system where no one really knows what's going on and it's not transparent, there are issues of fairness and a regulatory meltdown," Senator Ted Kaufman said in an interview.

Kaufman, a Democrat, is pushing regulators to speed up their review of the nation's financial market structure. He wants the financial regulatory reform bill being debated in Congress to include a provision requiring a fast review. Is there really a new threat of a financial Armageddon on Wall Street? Is the next market meltdown going to begin with a 25-year-old math whiz creating stock-trading programs that go rogue and create massive systemic risk? It is certainly the case that banks, hedge funds and proprietary firms have been using high-frequency trading to exploit minute movements in stock prices and quickly trade huge blocks of stock through complex computer algorithms. The fast trades now account for as much as 60 percent of U.S. equity trading, and there is growing concern that the structure of the market is set up to benefit sophisticated players and computers. And it isn't just politicians like Kaufman who have been raising red flags. 'CASINO CAPITALISM' "The interesting thing about the high-frequency trading community is we've created the perfect mixture for casino capitalism," said David Weild, founder of Capital Markets Advisory Partners and former vice chairman of the Nasdaq stock market. "The high-frequency trading community, algorithms and sophisticated side of the market are the house -- they have all the tools, and they have an advantage over everybody else." The odds, Weild said, are not in favor of traditional investors. According to a November study from accounting firm Grant Thornton, regulatory actions since the 1990s have encouraged the development of markets that favor technologically sophisticated traders at the expense of small companies that wish to use U.S. markets to raise capital cheaply. The study raised concerns that the market may have changed in a way that hurts capital formation in the United States by stripping liquidity from small companies. Gone are the big investment banking houses that once provided research for small companies. Also gone are the traditional floor specialists and market makers that once provided liquidity to a market by being ready to buy and sell many stocks at a moment's notice. The number of U.S.-listed companies has fallen by more than 22 percent since 1991, according to the study. "You could argue that transacting in stocks has become increasingly detached from company fundamentals," said Weild, a co-author of the study. "It's really this pursuit of 'faster and cheaper is better.' But that's not the case. Faster and cheaper has some nasty, nasty unintended consequences. It caters to traders at the expense of investors." Meanwhile, regulators are struggling to keep pace with the markets' changes. "There's a lot of concern about high frequency trading and what it's impact is on the marketplace and what it's impact is on investors who are in it for the long run," Mary Schapiro, chairman of the U.S. Securities and Exchange Commission told Reuters TV in October. "And we need to understand those but if the concerns are significant we won't hesitate to propose regulatory approaches to deal with it," she said. The SEC is trying to figure out what kind of effect ultra-fast trading has on long-term investors and whether it makes markets more or less efficient. "What is unfair is if trades are offered to high-frequency traders in a manner that regular customers can't do," said Albert Kyle, finance professor at the University of Maryland.

"Even if a customer is sitting at home placing orders, it's hard for those orders to compete effectively with algo traders because the algo traders are faster." Among the tough issues for regulators: deciphering the methods used by high-frequency traders to cover their tracks; whether it is possible to follow trades back to their original source; and whether the practice of "co-location" -- putting high-frequency trading computers as close as possible to exchange data centers -- is fair. The New York Stock Exchange has poured millions of dollars into a new data center outside New York in hopes that hedge funds and other high-frequency traders will rent out space next to the main exchange computers to shave fractions of microseconds off their trading times. Nasdaq, the Chicago Board Options Exchange and the International Securities Exchange also have direct feeds and data centers designed to attract high-speed traders. "I am certainly not under the impression that there is anything nefarious going on," Duncan Niederaurer, head of New York Stock Exchange parent NYSE Euronext, said in October. He sees no need to restrict high-frequency trades. Under some congressional pressure, the SEC recently proposed to ban so-called flash orders, which give advance knowledge of stock orders to some traders. The agency also proposed ways to shed light on so-called dark pools, which are trading venues in which buyers and sellers can remain anonymous. DO RAPID TRADES HELP MARKETS? But some worry that regulators will tinker too much with a system that could actually be stabilizing the stock market. "The high-frequency traders, even though they are unregulated, even though they have no obligation to be there, were there during the credit crisis, and the equity markets never closed. That is a remarkable thing because our credit markets froze up," said Al Berkeley, chairman of electronic brokerage company Pipeline Trading Systems and former vice chairman and president of the Nasdaq stock market. The SEC is expected to soon ask high-frequency traders to identify themselves and turn over trading data. Agency lawyers, economists and analysts will examine the data to determine whether the rapid trading creates market inefficiencies. Kyle suggests the SEC should consider some kind of rule that makes sure trading does not favor electronic customers over a mutual fund or a retail investor. In the meantime, a computer arms race is raging among the big Wall Street players and stock exchanges; exchanges are desperately trying to change rules to compete with brokers and dark pools, while at the same time moving to attract high-speed traders; and high-frequency trading shops, many of which performed well in the recession, are still attracting capital. This all comes as the Obama administration tries to reform U.S. financial regulation in wake of the worst economic crisis in decades. There are bills in the U.S. Congress to protect consumers from risky financial products and create a mechanism to unwind large troubled financial firms, but little in the way of moves to ensure that U.S. markets remain fair and accessible. "The big picture for me is that our U.S. equity markets are one of the secrets to our success over the years," said Senator Kaufman. "If they're not credible and they're not functioning so that small businesses can use them to actually get the money they need to grow into big businesses and create jobs, this country's in trouble."

U.S. SEC eyes hedge funds' high frequency trading

* SEC looking at whether trades have manipulative effect
Do fast trades make markets more or less efficient? WASHINGTON, Nov 20 (Reuters) - U.S. securities enforcers are looking at some of the high frequency trading that hedge funds are doing, a top Securities and Exchange Commission official said on Friday. The SEC is looking at whether "that trading is having a manipulative effect on individual stocks or other securities," said Scott Friestad, associate director of the SEC's Division of Enforcement. Friestad told a conference that within the past year, the SEC started eyeing the ultra fast trading at hedge funds. High frequency traders like hedge funds and banks use computer algorithms to buy and sell shares at lightning speed and capitalize on tiny spreads and market imbalances. Their activities have attracted the attention of policymakers who say the rapid trades and other recent market developments are favoring sophisticated investors. The SEC wants to have more information about the fast traders and plans to examine whether they are making markets more or less efficient.