jan10 feature trading

8/6/2019 Jan10 Feature Trading

1/6

featurestory4

the Tadewx high-speed business hlds n shaes at all. CmeMonday, Naang will look to tade millions moe shaes. It seemslike a lt, and it is, but Narang estimates that hes prbably nlysmewhee in the middle the tp 50 tades by lume.

Just ve years ag, autmated trades made up abut 30 per-cent the market, and ew thse mved as quickly as tdaystrades d. Since then, hwever, autmated trading has becmemuch mre widespread, and much quicker. Narang acknwl-edges stating his ultaast gup as a deensie maneue whenhe began t ntice aste tades eding the pemance his

medium-speed stategy. Now the medium-speed und is adoptingthe techniques he deelped in the ultaast und.The Tabb Grup, a cnsultancy based in Westbrugh, MA,

estimates that high-equency autmated tading nw accuntso 61 pecent o the moe than 10 billion shaes taded daily acossthe numeous exchanges that make up the U.S. maket. Tabb esti-mates pots om high-equency tading in the st nine monthso last yea at $8 billion o moe. With the ise o automation, thebulk o U.S. stock tading has moved om the once-cowded ooo Manhattans New Yok Stock Exchange (NYSE) to silent seveams un by exchanges and boke-deales acoss the county: thepptin all tades that the NYSE handles has shunk m

80 pecent in 2005 to 40 pecent today. Tading is now essentiallya vitual at, and its pactitiones put such a pemium on speed thatNASDAQ has consideed issuing equal 100-oot lengths o cablet the bkes wh send des t its exchange sees. (ThughNarang and his team prgram their algrithms n PCs in theirown oce, actual tading is done though bokes seves locatedn the pemises an exchangeNASDAQ, the NYSE, and dz-ens thes.)

The NYSE itsel is just inishing cnstructin a400,000-square-t data center in Mahwah, NJ. The new cm-

I Manoj Naang is about to bing down the makets, hes ce-tainly elaxed about it. Naang, who weas a goatee and wie-rame glasses, is casually dressed in a brwn shirt and darkgay sweatshit. Sitting on a swivel chai with one leg tucked

under the ther, he seems psitively cmpsed, especially r a

man wh has just bught and sld 15 millin shares with a ttalvalue $600 millin. Fr Narang, hwever, such vlume repre-sents just the start a nrmal day. Thugh its abut nn n aFiday mning, he has baely begun.

Narang is the head Tradewrx, a hedge und and nancial-technology m that makes puely automated tades; all decisionsae eached and acted on at nea light speed by computes unningpepogammed algoithms. Actually, we un two businesses, hesays. The st tades in and ut shaes in abut a secnd andholds them o an aveage o two o thee days. Thats the medium-speed und. The high-speed und could make thousands o tadesa secnd and hlds them a matte minutes.

By the end the day, his cmputes will hae bught and sldabut 60 millin t 80 millin shares, with the heaviest activityin the last hur trading, rm three t ur in the aternn.Tadewox and simila ms aound the county will ace to closebillions o bets that hinge on things like tiny difeences betweenthe pices shaes in an exchange-taded und hlding the S&P500 and the individual shares that make up the same index. Thepts g t the cmpany with the astest hadwae and the bestalgrithmsadvantages that enable it t spt and explit subtlemaket pattens ahead o eveyone else. At the end o a typical day,

Trading Sharesin MillisecondsTdays stck maket has becme a wld autmated tansactins executed at lightningspeed. This high-equency tading culd makethe nancial system me ecient, but it culdals tun small mistakes int catastphes.

By BrYANT U rSTADT

Photographs by STEv E MoorS


2/6

featurestowww .technologyreview.com

in a hurry Manoj Narang,ounder and head o Trade-worx, buys and sells millions oshares every day, using algo-rithms that oten execute thou-sands o trades per second.


3/6

featurestory6 technologyreview january/february2010

plex, slated t pen in the sping, will hae enugh cm-puting powe to handle evey tade on evey maket in thewrld, thugh the exchange will prbably have truble

gabbing much that business back. Hadwae used atthe acility will opeate at a 40-gigabyte-pe-second stan-dad, enabling it to handle as many as a million messagesa secnd. (The limit, in many cases, is nt the speed atwhich the inomation tavels but the ability o switchest ute it quickly enugh.)

The Tadewox oce in red Bank, NJ, a wealthy shoetown about an hou om Manhattan, is a a cy om WallSteet. A quiete place wuld be had t imagine. Abuta dzen emplyees, mst whm graduated rm tp-tier schls with degrees in science, math, r engineer-ing, wrk largely in silence. on this mrning, as thse

15 millin shares cme and g, the Tradewrx staf sayshadly a wd.

In Naangs ce, the shades ae dawn, the bette tread a large mnitr n ne wall. There are n tickersscolling by, no ashing updates on the value o the DowJones index. Naangs stategy is maket neutal, mean-ing that when it wrksand it usually deshe makesmoney no matte which way the maket goes. His potsdont depend on whethe shae pices ise o all; instead,he relies n a set algrithms that can nd and instantly takeadantage tiny, eeting mements in tading actiity. on thewall acrss rm the windw is a whitebard lled with cde: a

scribbled wchart in diferent clrs, with variables and cca-sinal amunts in bxes and the wds buy sell. In the middle the mnit is a lage numbe in a bx, ging up and dwn butmainly up. That is Tadewxs pt s a that mning.

A crAsh wAiting to hAppen?

High-requency trading has becme cntrversial, with criticschaging that tades ae manipulating the maket, taking adan-tage the little guy, and een cuting a ull-scale nancial melt-down. The citical voices ae gowing loude and moe united, andtheye eaching highe up the ungs o powe. In Septembe, Sena-t Edwad Kauman (DDelawae), speaking n the the

U.S. Senate, wied that the United States was ming twad asituatin with ne maket huge-lume, high-speed playes,wh can take adantage eey lphle pt, and anthemarket r retail investrs, whse rders are seemingly lled asan atethught. The Secuities and Exchange Cmmissin hasrecently prpsed a rule t eliminate ne cntrversial tactic high-equency tades: the ash tade, in which exchanges aletdesignated traders t incming rders. Critics call it a variatino ont-unning, an old (and illegal) pactice that involved tadesbuying and selling in adance lage des.

But accusatins unainess ae nt the nly issue. Any tendthat becmes as dminant as high-requency trading shuld bestudied t cnsider ptentially serius side efects, warns PaulWilmott, the publishe o the quantitative-nance jounal Wilmottand the under the mathematical-nance diplma prgramat the University oxrd. High-requency trading is the lat-est bandwagn, and eeyne is jumping n bad, he says. WallSteet always piles n t the next thing, and it always blws up.

Wilmtt, a sel-described instinctive cntrarian wh cr-ectly waned in 2000 that the deivatives maket was dangeously

unstable, sees particular threats rm this trend. The increasingdominance o algoithmic tading and the gowing speed o execu-tin, he says, culd cause tiny price changes t snwball, rllingdwn the hill at expnentially increasing speedeither becausethe machines ae tading t ast because t many unds aetading in the same style. The potential is thee o a cash to hap-pen quite quickly, he says.

Bernard Dneer, wh versaw electrnic trading at FidelityInvestments rm 1996 t 2002 and nw teaches abut inrma-tion technology in nancial makets at Bauch Colleges business

Buy! Sell! In Tradeworxs ofces in Red Bank, NJ, employees work innear silence, programming the algorithms that allow the company to proft-ably execute its speedy trading programs. Far rom Wall Street, frms thatspecialize in this high-requency trading represent an increasingly large

portion o activity in the fnancial markets.


4/6


schl in New Yk, wies that high-speed algithmic tadingwill lead t a smalle-scale esin the cash 1987, when themaket dopped 22 pecent in one day. Many now blame that cash

n simple autmated prtli insurance systems, which weremeant t keep a unds hldings rm lsing mre than a presetamunt value by autmatically selling shares when the pricedrpped by a certain amunt. They had their rts in a practiceused by oo tades: the stop loss ode, which initiates the sale a gien shae i it alls belw a gien pice. But the hed cm-putes issuing stop-loss odes ceated a stampede that pushed thethen-dominant oo tades to sell as well. Donee woies that isuch a sell-f happened nw, it wuld happen many times aste.

While such oced selling can be the esult o oethought (mis-guided o not), it can also stat with a mistake: pessing an exta but-tn (what tades call at-nge syndme) btching the cde

that dies an autmated algithm. In 2003, shaes CinthianClleges, a cmpany that manages r-prt educatinal institu-tins, plummeted when aulty cde human e caused a cm-pute t begin selling shaes its use did nt hae. The system had

been prgrammed t sell i the security returned t the price atwhich it had been bought. When that time came, the compute soldthe shares the custmer held and just kept ging. In 12 minutes, itsld sht nealy thee millin shaes at pices m $57.50 all theway down to $39.50. In a maket dominated by high-equency tad-ing, such glitches culd mushm within secnds.

Even some high-equency tades woy about what Doneecalls algs gne wild. Jhn Jacbs, the Coo the New YrkCitybased Lime Brkerage, wrte the SEC in 2009 t vicecncerns ver the prlieratin brkers wh allw majr cli-ents to engage in high-equency tading without validating thei

marginsthat is t say, withut making sure they actually haveenugh mney t back a trade. Lime prvides high-speed mar-ket access and de alidatin t hedge unds and the tades,sme whm cannt, r dnt want t, place their wn serversn an exchange r. In his psitin, Jacbs regularly sees alg-rithms executing mre than 1,000 rders a secnd. At that rate,one algoithm tading the wong way could execute 120,000 odesin tw minutes. At 1,000 shares per rder and an average price, say, $20 a share, thats $2.4 billin in unintended trades. Inhis letter, Jacbs warned the ptential r trading-induced

multiple domino bankuptcies. He cautioned that unestainecmputer-generated trading has the ptential t create castphic ecnmic damage t the U.S. natinal maket system

penny pinching

The playes in high-equency tading ae many and aied. Smare institutinal investrs like pensin unds, endwments, anmutual unds; othes ae bokeages o tading desks at banks, usinthe banks wn mney. Enrmus hedge unds like the CitadInvestment Goup in Chicago use these techniques, and so do staups like PhaseCapital in Boston, which began tading with just thpatnes money in the sping. Designated maket makestadelicensed by an exchange t create a stable market in a security bmaking it available to both buyes and selles in an odely ashiouse high-equency stategies t ll des and t hedge psitin

cnstantly rebalancing inventry s as nt t get caught with tmany r t ew shares. And the eld will nly grw. Cmpaninw fe high-equency packages that include stwae, bkeage hkups, and as much cnsulting as yu can afd.

Indeed, in many ways, pactices associated with high-equentrading have becme a rutine part hw the market peratWhen a custome places a tade though a Chales Schwab accouo example, that ode is likely to be handled by a high-speed algrithm. Institutinal traders like Fidelity, which buy large blc shares r their mutual unds, use algrithmic trading t sptheir enrmus rders int blcks 100 t 300 shares s thothe tades dont ecognize the tue demand and take advanta that knwledge thei wn pt.

Hedge unds with high-equency opeations, like Tadewowok between and aound the institutional tades and the mak

makes, and against each the, attempting t pt by anticiping the moves o othes. Thei eliance on statistical pattens anquantitative analysis has wn them the name quant und(A quant und typically hlds a prtli derived rm statiscal analysis, but its trades may take place ver mnths as well micrsecnds. Thugh mst high-requency unds are quaunds, nt all quant unds trade at high requency.) The expsin in high-speed autmated tading has engendeed a massibuildup in technlgy; renaissance Technlgies, a hedge unbased in East Setauket, NY, basts that its cmputing pwer

One executive warns of the potential for trading-inducedmultiple domino bankruptcies. He says that unrestrainedcomputer-generated trading has the potential to create cata-strophic economic damage to the U.S. national market system.


5/6

featurestory8 technologyreview january/february2010

equal to that o the Lawence LivemoeNatinal Labaty.

Just one example o what speed can do

explains a lot about how high-equencytrading wrks and why it angers smebservers, as Jseph Saluzzi and Sal

Arnuk, the principals the New Jer-seybased Themis Tading, made cleain thei 2008 white pape Toxic EquityTrading order Flw n Wall Street.Imagine that a mutual und enters abuy rder, telling its cmputer t startby ering the current market price $20.00 a shae but t take any askedpice up t $20.03. A high-speed tade,

Saluzzi and Arnuk explained, can usea pedaty alg t identiy that limitby pinging the maket with sell odesthat are issued in ractins a secndand canceled just as ast. It might startat $20.05 and wrk its way dwn t $20.03, canceling and rer-deing until the mutual und bites. The tade then buys close tothe cuent $20.00 pice m anthe, slwe inest, esellingt the und at $20.03. Because the high-requency trader has aspeed advantage, he is able t d all this bere the slwer partycan catch up and fer shares r $20.01. This speedy player hasound the buyes limit, gatheed up and sold an ode, and snipped

a ew pennies f himsel.

Liquidity And order

Picking up all thse pennies can be risky, Narang says, but hemakes what he consides an impotant distinction. Thee is isk,denitely, but quant unds like us take it all, he says. I a quantmeltdwn happens, it wnt afect the etail inest.

Naang tuns to his compute and bings up two gaphs, supe-impsing ne n the ther. The rst shws the erratic up-and-down cawl o the S&P 500, the value o the lagest 500 companiesin the United States, ver the last six years. The secnd shwsTradewrxs prt and lss ver the same perid. It is a steady

mach up; in Tadewoxs wost yea, it made 15 pecent. All [high-equency] unds have a pot-and-loss line like this, he says. Thenhe magnies the gaphs to show just the weeks aound August 2007,when many quant unds sel-destucted as they sld f thei pt-lis t meet increasing margin calls (see The Blow-Up, Novem-ber/December 2007 and at www.technologyreview.com). In those days,his P&L dpped by 7 pecent, and many the unds saw similalsses. But the S&P 500, eall, was little afected.

And hees the second quant meltdown, in Januay o 08, Naangsays, zooming out and then in on anothe blip in the gaph, showing

Take a snapshot o this code with your smart phone to see a specialreport on smarter IT. For the sotware, visit www.neoreader.com.Watch an interview with Tradeworx CEO Manoj Narang:.lv.m/a

the alue the S&P 500 when a secnd, albeit smalle, dislcatin

ccurred. Its tiny. Yu can hardly see it. Thats because unds run-ning quantitative strategies are mstly market neutral. When wetake a psitin, were always balanced smewhere else, and whenwe unwind, it doesnt afect the maket eithe. By this he means thatoced selling by quant unds may be painul o the unds themselves,but that pain is baely eected in the maket, because the unds longand shrt psitinspsitive and negative bets n the directin given securitiescancel ne anther ut. We dnt take rm theetail guy, he says. We make the maket me ecient. Things aebette the etail inest because high-equency tading.

Naang, and academics like Dnee, say that high-equencytraders are making mney by delivering a service: liquidity. In

todays highly decentalized maket, deendes say, thei systemsae simply the most ecient way to match buyes and selles. Andbecause they can capitalize on small difeences between the picesat which a selle is willing to sell and a buye is willing to buy, those

caShing in On a recent morning, Tradeworx bought and sold 15 mil-lion shares beore noon. Speed means profts as the company racesagainst other frms using similar high-requency tactics to take advantageo small movements in the markets. A monitor (lower right) at Tradeworxsofces keeps track o the net trading operations during the day. It gener-ally ticks up.


6/6


difeences stay small. The upsht is that etail buyes pay a littleless to buy a shae and can sell it o a little moe. Indeed, since elec-tonic tading has come to dominate the maket, speads betweenbuying and selling prices have decreased dramatically, and shae ees. Ten yeas ag an inest might hae paid $150 in eesto tade 500 shaes with a boke, acing a spead o maybe a dimen each shae. Tdays etail inests pay $10, with speads apenny s in mst big stcks, and mst thei tades ae lled

almst instantly.Understanding hw high-requency trading imprves liquid-ity explains a lt abut why many such tades d well when themaket is plunging latile, as it was last yea. We dnt makevlatility happen, says Narang. We reduce it, but it is hw wemake ur mney. We create rder. When the markets are disr-dely, we make a lot o money, but we ae doing it by estoing themakets t de.

I Naang is ight, the new ways ae good o the etail investo.But the agument that high-equency unds impove liquidity, as

i they wee poviding a public sevice, is distubingly eminisceo the justications ofeed by hedge unds and banks that ceatcomplicated deivatives in the yeas leading up to the ecent casWhen things went bad in that case, the liquidity disappearealng with many the unds inested in them, and much thinvestos money. And this type o histoy doggedly epeats itseWilmott, o one, is not convinced that high-equency tadinguseul to the economy. People have to say things ae ne becau

theye being ewaded it, he suggests.At least r nw, thugh, things are calm, and the spreads anaw. Ate lunch, Naangs day at Tadewx stats t get busias hundreds high-requency unds jstle t clse ut their ptions to thei best advantage. Naang says good-bye at the doo, hwrds the nly sund in the quiet ce. on the wall behind himTradewrxs daily prt-and-lss line still ticks up and dwn, bmstly up.

Bryant urStadt iS a writer BaSed in new york.

jan10 feature trading

Documents