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. It’s a man’s 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 (Investor’s 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 100µs = 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. It’s a man’s 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 µs

• 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 2µs (1µs + 1µs processing time)
• Quote should reach SIP after 21µs (but actually 250µs)
• Original time stamp gets scrubbed and replaced with new time stamp
• Flash crash 2010: delays of up to 30 seconds (30,000,000µs) 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 µs

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-1980’s 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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