How high-frequency traders benefit us all

By Felix Salmon
April 4, 2012
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File under “unexpected societal benefits of high frequency trading”: it’s doing wonders for building IT infrastructure. Sebastian Anthony and Jeff Hecht both have good overviews of the three — count ‘em — fiber-optic cables being laid deep below the arctic sea floor, all in a $1.5 billion attempt to shave 60 milliseconds, or less, off the amount of time it takes to get digital information from London to Tokyo.

None of this would be possible without global warming, of course:

Each cable will be laid by a pair of ships: an ice breaker that leads the way, and a cable ship. Until now it has been impossible to lay cables in the Arctic Ocean, but the retreat of the Arctic sea ice means that the Northwest Passage is now generally ice-free from August to October; a big enough window that cable can be laid fairly safely.

But global warming alone isn’t enough to make the economics make sense: standard cable ships aren’t rated for icy waters, so polar-rated ships have to be retrofitted for the job instead, at vast expense.

And yet three different companies have managed to make the economics work, even while offering only tiny decreases in latency: according to Arctic Fibre, the speed of the London-Tokyo connection is going to be reduced from 188ms to 168ms, a reduction of just 20ms.

Everybody will benefit from these cables, not least because they will bypass the current “choke points” in the Middle East and in the Luzon Strait between the Philippine and South China seas. But most of us are unwilling to pay for insurance against a ship dragging an anchor in an inopportune location. High-frequency traders, on the other hand, are willing to pay a lot.

The leaders of the project will need to persuade telecommunications companies to buy a piece of the capacity created by the cable. Telecom companies will make that decision largely based on demand from financial companies.

“What we’ve seen is just because you have a diverse path does not mean that you can necessarily sell that capacity for much more than the current market price,” Mauldin said.

I’m a little bit unclear on exactly how these cables are financed, and what the mechanism is whereby telecommunications companies sell ultra-fast connections to financial-services companies. But clearly it’s advanced and predictable enough that the economics make perfect sense for more than one player.

It’s lucky, then, that laying cable under the arctic makes a key financial connection noticeably faster. That cable would serve a very valuable purpose even if was a little bit slower than current connections — but in that event, no one would have any incentive to lay it. Are there any examples of people spending a lot of money to lay big fat pipes which are slower than what already exists but which simply expand the total amount of bandwidth available? I suspect the economics in that case would be much more difficult.

31 comments

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Felix,

Do you really think that laying three fiber-optic cables underneath the Arctic sea floor in an effort to shave 60 milliseconds of trade execution times is the best use of $1.5 billion in capital? How exactly does this benefit society at large?

Personally, I can think of a lot of other ways to use $1.5 billion in capital that would provide far more benefit to society.

Posted by mfw13 | Report as abusive

Felix, you should read Mother Earth Mother Board. It is a fascinating, in-depth article that was written by sci-fi / cyberpunk author Neal Stephenson and published in Wired magazine. It’s a long read, but it delves into the many difficulties and intricacies of laying transoceanic fiber optic cable profitably.

http://www.wired.com/wired/archive/4.12/ ffglass.html

Posted by JonHocut | Report as abusive

Mfw13, I don’t think Felix is suggesting that this investment is a good use of capital, just that society will benefit from paper traders never-ending desire for legal inside information (it’s only inside for a few milliseconds). I think he is implying there is no direct benefit to society ,but we at least get a good second order effect.

Posted by KenG_CA | Report as abusive

You have to differentiate between latency and bandwidth. For most people, increasing bandwidth does increase speed, as the objects they want to move are large enough that queueing or packet loss causes more delay than latency.

So, I am sure there have been expansions of of bandwidth that slowed latency. This could be because of equipment changes on the ends of the fiber, avoiding certain exchange points, political/legacy considerations about where to land your cables, etc.

Overinvestment drives telecom, so these projects aren’t guaranteed to make a profit for the people doing them. Then again, latency might turn out not to be a commodity, which would be unique for a resource in the technology world.

Posted by AngryInCali | Report as abusive

You’re conflating extra bandwidth with lower latency, no? Extra bandwidth is useful to the internet at large. The pursuit of ultra-low latency links is however of no lasting use to anyone.

Posted by max.c | Report as abusive

“three — count ‘em — fiber-optic cables being laid deep below the arctic sea floor”

wait – didn’t Worldcom or Quest or someone do this back in 1998??? How quickly cycles repeat these days…

Posted by KidDynamite | Report as abusive

Prohibition had the effect of reducing alcohol consumption for decades following its repeal.

Despite that, it was still a disaster that produced great harm to society fostering the creation of lawless and predatory organizations.

To paraphrase Monty Python, “Intercourse the bloomin’ HFT traders.

Posted by Matthew_Saroff | Report as abusive

The latency benefit results of shorter distances over FOC and the fewer number of routers and repeaters the signal goes through. Another benefit not mentioned here is the increase in bandwidth in currently under-served regions, namely northern Canada. In some cases it frees satellite space and provides opportunity for distance learning centers to be established. Although the intent of the providers is purely financial (yes customers do pay a premium when provisioning links such as this one) the side benefit is far greater than the nay-sayers imagine.

Posted by OnkelBob | Report as abusive

KD

It was Global Crossing that got into the trans oceanic cable business in ’98 (it bought the submarine cable laying business of AT&T). Quest laid their’s along railroad right of ways.

Posted by crocodilechuck | Report as abusive

Felix,

High-frequency trading is largely responsible for accelerating our financial problems to the point where they are now out of control.

Technology has clearly outstripped man’s ability to deal with it, thus making the global economy a whole lot more unstable than it should be.

If something goes wrong (like the “flash crash”) we can’t stop the cascading failures before it does serious damage.

The present situation is like the bad plot of an old sci-fi movie, where the computers become sentient and wipe out mankind.

If all these interconnected systems fail, that sci-fi plot could become all too real.

That’s NOT a good thing, I don’t care how you care to look at it.

And I’m still trying to figure out how high frequency trading has helped me personally. Maybe I missed the check last month or something. It would seem to me all the benefits go to the wealthy, and we get to pay for the IT investments.

Posted by PseudoTurtle | Report as abusive

Haha, the intent is obvious to me!

Now the carcasses of American and European markets have been picked clean of HFT arbitrage opportunities, New York traders need to find new game to hunt.

Time to front-run the Teacher’s Retirement Funds of Tokyo and Shanghai.

Posted by DanHess | Report as abusive

PseudoTurtle, I believe the standard, University of Chicago/Booth School of Business/Neoclassical Economics/Markets are Perfect school of thought answer is: high frequency trading helps you by increasing liquidity in the market, and hence equilibrium prices are arrived at faster, thus making the market more efficient.

I personally am not convinced. High frequency trading mostly helps the large banks and investment firms with prop trading desks extract money from everyday investors and direct it toward the salaries and bonuses of the sharks on Wall Street. Of course, if you say that out loud, someone will come along to tell you that you really just don’t understand financial markets, so don’t worry your pretty little head about these things.

But Felix is right that a lot of IT infrastructure is being funded by folks pursuing HFT.

Posted by Strych09 | Report as abusive

It’s disappointing Felix Salmon is uncritically repeating the misguided claim HFT is pushing for this low-latency link. 60 milliseconds is an eternity in the world of HFT. HFT firms will fight over who gets the rack at the far end of a server room because each additional meter adds microseconds of latency, to the point where exchanges have considered making all cable runs the same length to ensure a level playing field. HFT firms in Japan can simply buy machines in London and remote-control them, instead of attempting to compete from Japan with local computers that have a 60ms head start..

No, the real market for this service lies with arbitrageurs, where transactions need information from both London and Tokyo exchanges, not HFT algorithmic traders who only need data from one exchange. I suspect forex rate arbitrage will be the primary application, it’s certainly a big enough “industry” to fund this kind of infrastructure over the lifetime of an intercontinental cable.

Posted by FazalMajid | Report as abusive

Strych09, the largest HFT firms aren’t on wall street but as usual don’t let facts get in the way.

Posted by Danny_Black | Report as abusive

It just proves the point of how dangerous HFT is by proving the disconnect between stock valuations and trading.

The stock market has become a hackers platform, not a market of stocks for creating capital for companies.

HFT has no value what so ever.

Posted by markcuban | Report as abusive

I am not sure such high cost is justifiable given wireless microwave communication are taking front seat, reducing latency by 30%, than fibre optics.. Pl see below link on it..

http://www.hftreview.com/pg/blog/sbenti/ read/42378/the-race-to-zero-metro-wirele ss-high-frequency-trading-networks

- A jay

Posted by ahjay | Report as abusive

Slackul, the argument that all HFT is justified because of lower transaction costs is a joke. The marginal value to any investor is minimal at best, but when looking at the risk incurred by that same investor as a result of HFT, that cost advantage and then some disappears.

There is a reason why the exchanges are pushing for more retail transactions, because they are the “suckers” that traders can take advantage of.

There is a reason why most quotes are cancelled in milliseconds, the goal is to mislead the market.

Then there is the lie about liquidity. By definition no algo trader is going to trade anything unless there is already liquidity. The liquidity HFT traders bring to market is actually harmful given they have no responsibility to retain any level of liquidity (irealize this may change)

Then of course there is the nuclear problem of HFT. Like the movie War Games, when programs interact with programs enough times we will come to realize the only certainty of the software world – that all new software has bugs. Given the short shelf life of algorithms and the rush to enter new markets and trade new equities its only a matter of time before two algos go at it in a game of Equity ThermoNuclearWar and we dont realize what has happened until its too late.

It all comes down to this, “what is the purpose of the stock markets and any exchange trading any instrument?” Is it to create capital for investment and liquidity, or is it a platform for software hackers to play with ?

m

Posted by markcuban | Report as abusive

We have a direct genuine provider for BG/ SBLC specifically for lease, at leasing price of 6+2 of face value, Issuance by HSBC London/Hong Kong or any other AA rated Bank in Europe, Middle East or USA.

Contact: Mr. Felix Burke

EMAIL: felixburke@live.co.uk

TEL: +44-8442448277

Posted by fbk | Report as abusive

High Frequency Trading is theft. I hope that a per transaction tax is instituted to make it unprofitable.

Posted by AZWarrior | Report as abusive

To actually respond to Felix’s questions:

“I’m a little bit unclear on exactly how these cables are financed, and what the mechanism is whereby telecommunications companies sell ultra-fast connections to financial-services companies.”

Usually what happens is that a company or consortium announces plans to build a cable and then drums up enough pre-commitments from customers to convince banks or other sources to stump up the cash.

Very few financial companies operate at the scale to buy direct from the fiber operator so instead telecoms buy capacity and resell it, usually with some of their own network to offer more convenient interconnections than the landing stations at either end.

“Are there any examples of people spending a lot of money to lay big fat pipes which are slower than what already exists but which simply expand the total amount of bandwidth available?”

Of course. Most cable builds are primarily to add capacity and/or redundancy (Hibernia Atlantic’s “Project Express” is a notable exception). Their latency quite often doesn’t differ much from existing cables but nor will the builder spend extra money optimising for latency.

And to all those wondering about HFT’s use of these cables, it’s actually a really big market. You really think humans are doing all that inter-market arbitrage?

Posted by MartinBarry | Report as abusive

This and other topics that are relevant for speed traders and institutional investors will be discussed at High-Frequency Trading Leaders Forum 2013 London, next Thursday March 21.

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