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NEW EUROPEAN COLLEGE HIGH FREQUENCY TRADING

High Frequency Trading


Around The World in 0.13 Seconds

Alex Gloy
Lighthouse Investment Management

October 26, 2017


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Bio:
1988 Traineeship Deutsche Bank, Hamburg
1990 Master in BA, Fribourg University, Switzerland
1994 Credit Suisse, Zurich
Sales, Sell-side Research, Buy-Side Research
1998 Sal. Oppenheim, New York
2000 Lombard Odier Darier Hentsch, New York
2006 Sal. Oppenheim, New York
2009 Lighthouse Investment Management

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1. What is High Frequency Trading


2. What is not High Frequency Trading
3. US Market Structure
4. Where is Wall Street?
5. First Encounter with an Algorithm
6. Its a mans machines world
7. The SIP versus Direct Feed
8. Race for Speed, Bandwidth and Computing Power
9. Flash Crashes
10. Share Buy-Backs
11. Are Stock Prices Representative?
12. Conclusions

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1. What is High-Frequency Trading?

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Definition High Frequency Trading


High speed
High turnover
High order-to-trade ratio

Key Attributes
Sophisticated algorithms
Co-location
Very short-term investment horizon

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2. What Is Not High-Frequency Trading?

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Hamburg Stock Exchange

Banks Front
Offices
Market Trader
Maker

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3. US Market Structure

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Tesla Order Book

US Stock Exchanges:
BATS Global Markets, 2005
Nasdaq (National Association of Securities Dealers
Automated Quotations), 1971
Direct Edge, 1998
NYSE Arca, 1994
Chicago Stock Exchange, 1882
IEX (Investors Exchange), 2012
NYSE (New York Stock Exchange), 1817
NYSE American Stock Exchange, 1908
Nasdaq OMX Boston, 1834
Nasdaq OMX Philadelphia, 1790

US Options Exchanges:
CBOE (Chicago Board Options Exchange)
ISE (International Securities Exchange)
BOX (Boston Options Exchange)
Miami International Securities Exchange
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Market share by exchange:


21% BATS + Edge
21% Nasdaq + Boston + Philly
19% NYSE + Amex + Arca
38% Dark Pools

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Lit market (i.e. NYSE):


Order book visible for all
Not optimal for large orders
Legal immunity

Dark pool (i.e. Instinet, SIGMA X):


Off exchange
Reported after the trade happened
Blocks of large number of shares
Internalization of order flow

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Bid Ask

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4. Where Is Wall Street?

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NYSE Primary Data Center, Mahwah, New Jersey


Our liquidity centers
are among the most
robust in the world
and they enable
customers to co-
locate their
equipment.

Speed: 1-40 GB/sec

(T1: 1.5 mbps


T3: 44 mbps)

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Equinix's NY4 data center in Secaucus, New Jersey


No-name, window-less building
5-layer ultra-high security (man
trap entry, 24/7 guards, biometric
hand scanners, card, pin)
Hosts 49 exchanges
Delay coils as 1 foot = 1 ns
1 sec = 1,000 millisecond
1,000 milliseconds = 1 micro
1,000 micro = 1 nanosecond
Every customer 1,000 feet away

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18 diesel generators, 2.5 MW each

180,000 gallons diesel


5,600 back-up batteries
1 MW = 1,000 homes

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Circle =
Distance light travels in 100s = 0.1ms
= 0.0001 seconds

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Almost 50% of all orders


cancelled within 0.1 seconds

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~30% of quotes
have already been
cancelled by the time
they reach Europe or
the West Coast

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5. First Encounter with Algorithm

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Algorithm
Algorismus (Latin) + arithmos (Greek = number)
Algorismus = Latinized from Al-Khwarizmi (native of Khwarezm)
Persian mathematician (780-850)
Wrote Compendious Book on Calculation by Completion and
Balancing, aka Al-Jabr (Algebra)

Algorithm = mathematical solution for a problem

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Price

Volume

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6. Its a mans machines world

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Robo-journalism:
Associated Press (sports, company
earnings previews and reviews)
Forbes
ProPublica
LA Times
Google (local stories)
Washington Post (Heliograf)
Bloomberg News

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Dangers of robo-journalism:
June 2017: alert by US Geological Survey software about earthquake
which occurred in 1925

2008: UAL shares fell from $12.30 to $3.00 after a story from 2002
bankruptcy filing was digitalized and uploaded by the South Florida
Sentinel Sun (which feeds into Bloomberg News)

April 2013: FOMC meeting notes released 24 hours early by accident

September 2013: FOMC decision (no taper) after changing rules from
lock-up to embargo
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September 18th, 2013 (No


taper announcement)

First 3 seconds of trading:


price +1% after 3ms
Buyer scooped up all resting sell
orders in the book up to 128
No more trades after first 0.178
seconds

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First 0.4ms:
155 trades with same
timestamp
60,726 volume
Price +0.4%

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NASDAQ data center in


Carteret, NJ

Federal Reserve K-street data


center in Washington, DC

189 miles = 1,014 s

News has been pre-


loaded on machines at
NASDAQ

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Thompson Reuters, University of Michigan Consumer Sentiment Index

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Release schedule:
10:00:00am non-subscribers
09:55:00am most subscribers
09:54:58am ultra-low latency subscribers

Employee went to FBI,


was fired

Minor clock
synchronization issue

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7. The SIP versus Direct Feed

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SIP = Securities Information Processor

NBBO = National Best Bid and Offer (required)


Depth of book => direct subs

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Time stamp scam / latency arbitrage


Exchanges must provide trades & quotes to SIP as fast (or faster) than to direct
feed clients
Quote leaves exchange (NASDAQ, Carteret) at 9:45:00:000, gets time-stamped
Quote reaches direct feed client after 2s (1s + 1s processing time)
Quote should reach SIP after 21s (but actually 250s)
Original time stamp gets scrubbed and replaced with new time stamp
Flash crash 2010: delays of up to 30 seconds (30,000,000s) between SIP and
direct feed, impossible to detect because of scrubbed time stamps => trading on
stale prices
Around 40% of trades based on SIP prices. SIP can get locked or crossed due to
stale input from 13 exchanges => internalizers stop trading until resolved
1GB versus 40GB line
TCP (transmission control) versus UDP (user datagram) protocol
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Direct Feeds have 500ms


advantage over SIP:
Time to process NASDAQ
quote in s

NYSE
ARCA
SIP

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120,000 stock trades per second 23 billion option quotes/day (1m/sec)

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Option quote capacity:

2007: 359,000 per second


2011: 1,000,000 /s
2015: 42,100,000 /s

Actual 2016: 350 billion per day


(15m/s)
1 quote: ticker + price + volume +
time + order type
1 character = 1 byte
1 quote = at least 200 bytes
42.1m quotes/s = 8.42GB/sec

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170+ order types


Common Time Auction Peg Other
Market GTC Market at open Pegged Cancel/replace
Limit Day Limit at open Market peg Cancel on halt
IOC Market hours Market at close Midpoint peg Sell short
IMS Extended hours Limit at close Primary peg Directed
FOK System hours Imbalance only Market maker Inside limit
Stop GTD Opening cross NBBO offset Auto ex order
Stop limit Alt. midpoint Not held

Hide-not-slide
Avoid locking market
Keep queue priority

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8. Race for Speed, Bandwidth and Computing Power

Chicago (futures) > New York (stocks) = 720 miles = 3.9 milliseconds one-way
Provider Technology Completion Miles Milliseconds Approach
Buried cable Fiber Optic Mid-1980s 1,000 14.5 Along rail lines
Spread Networks Fiber Optic 2010 825 13.1 Own way-of-right
McKay Brothers Microwave beams 2012 744 9 20 towers
Tradeworx Microwave beams 2012 731 8.5 $250,000 per year

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9. Flash Crashes

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SMI future flash crash May 6, 2015

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August 24, 2015 (ETF flash crash)

ETFs fell 30-40%

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BATS Global Market IPO, March 23, 2012


Offering price $16
10:45-11:20 BATS halts trading in symbols
A-BFZZZ due to 3 bad trades in AAPL
triggering circuit breaker
11:14:18:436 BATS opens on BATS at
$15.25, volume 1.7m shares
11:14:18:444 NQ opens at $15.75
Bid steps down rapidly
ISO sell order hammers all bids
Offer flickers wildly between $0/$50,000
11:14:19:778 NQ at $0.04, low $0.0002
11:14:19:779 Trading halted
IPO cancelled

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10. Share Buy-Backs


Putting a floor on stock price (making life of short-sellers difficult)
Enabling executing broker to earn free money as buy-back program provides a
very short-term
put option for free
Enable
companies to
increase earnings
per share without
an increase in net
profit

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Are Stock Prices Representative?

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11. Conclusions

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1. Liquidity and Price = mirage


2. Flash crashes can happen any time
3. Beware of fat-tail events (not in risk models)

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