
Bootstrapping an Ultra Low Latency Trading Firm, Part 2 - veyron
http://veyronb.wordpress.com/2011/08/01/bootstrapping-an-ultra-low-latency-trading-firm-part-2/
======
snikolic
What bothers me is how simple this is. This is simple arbitrage that anyone
with access to wikipedia could figure out in a few days.

What makes these strategies profitable is exclusive access to information -
not actual investing prowess. It's about who can afford to buy the fastest
hardware on the fastest pipes in the closest proximity to the exchanges and
top tier e-brokers. It's frequently even about who you know.

If your only competitive advantage is systemically restricting the public's
access to information, you're doing it wrong.

(but my inner nerd thinks this is super cool, and my inner Gordon Gekko wants
to get started today)

~~~
veyron
There is a signficant cost to obtain data and most of the seemingly simple
trades don't make much money anymore. Purchasing realtime market data is very
expensive, and you generally need to make 1000$ per trading day to break even.
It's not easy in this economic climate, especially if you are trading your own
money.

Amongst other things, dark pools and alternative venues have sucked a lot of
liquidity that would traditionally hit the market.

The reason the information is available on Wikipedia is because people like me
contributed to many of the wiki articles on the topic :)

The profitable opportunities themselves are fleeting and tiny, which means
only the first few traders actually get the trades they want. This, coupled
with the sheer number of firms (in the hundreds) forces traders to do what it
takes to minimize their delays, including obtaining lower latency market data,
high performance servers and proximity. And yes, some exchanges (like NYSE)
definitely play favorites.

~~~
snikolic
What happens to the industry when market access and data is openly available
at an affordable price and a speed/scale comparable to what professional
traders currently have access to? And why hasn't this been done yet? As an
outsider to the financial industry, it looks like this information/access is
slowly becoming commoditized (IB, Lime, etc.)... is there going to be chaos
when any HN reader can begin low latency trading (or mining market data) as
easily as they could get started on a service like Twilio?

Why are so many exchanges still private? Why do you have to pay exorbitant
amounts of money for an exchange seat or high-quality exchange access? Why do
some exchanges have designated market makers? Are these systems actually
effective, or is this just nepotism among bankers?

Disclaimer: I have no idea what I'm talking about; I'm legitimately curious
about this stuff. Hope I'm not coming across as too brash/angry. :-)

~~~
veyron
All of your questions will be resolved if you understand one key fact:
"Exchanges are companies". If you want to know why they are not government
entities, imagine the GOP backlash if they tried to own and run an exchange
(I'm not sure how democrats would respond, but republicans would definitely
cry wolf). They are businesses, which is why:

\- market access and data will not be openly available at a reasonable price
(you have to spend extra money if you want to redistribute the data). Yes,
this is a profit center for the exchanges

\- Exchange seats will be limited and cost money (profit center)

\- Colocation will always cost money (people are willing to pay to colocate)

As far as DMMs are concerned, there is a legal obligation to place orders and
offer a buy and sell price. More specifically, they are required to be at the
inside bid or offer (buying at the best buy or selling at the best sell price)
most of the time. This ensures that there's a reasonable counterparty when
some other trader wants to buy or sell. There is some economic incentive to be
a DMM, but they provide a real service to the markets.

A few example exchange companies that list on public exchanges:

NDAQ: NASDAQ OMX Group lists

NYX: NYSE Euronext

CME: CME Group (Chicago Mercantile Exchange)

~~~
snikolic
Regarding corporate exchanges: they may be private companies, but they are
heavily regulated and considered vital pieces of our economy. How can we
sanely say something is financially vital to our country, and then exclude
99.9% of the population from it?

Regarding exchange business models: What about a transactional business model?
Give people free access to the market, cut out the brokerage middle men, and
charge players to place transactions?

Regarding DMMs: if there's a financial incentive to add liquidity as a DMM,
why wouldn't the market naturally fill the role? Why auction the role off to
the highest bidder?

~~~
veyron
"How can we sanely say something is financially vital to our country, and then
exclude 99.9% of the population from it?" <\-- How can we declare a private
bank "too big to fail"? I mean, no we can't, but this isn't the only insane
situation here.

"What about a transactional business model? Give people free access to the
market, cut out the brokerage middle men, and charge players to place
transactions?" <\-- who fronts the cost of the exchange? Electricity, rent,
salaries, etc. Amortizing the cost through trading fees isn't fair to those
who trade, because there would be users of data who don't end up paying at
all. I think if you accept that they are private businesses, the pricing model
makes sense.

" why wouldn't the market naturally fill the role?" Let's say the market
starts falling rapidly. In a pure-market system, no one would be able to sell.
The DMM obligation ensures that, at the very least, some people would be able
to sell at some reasonable price. Think about insurance companies: you make a
small amount of money most of the time, and every once in a while you need to
make a large payout.

------
Sukotto
Nice post veyron. Please keep it up.

For those interested, here's some other good reading on this topic while you
wait for veyron's next post :)

\- <http://www.technologyreview.com/blog/mimssbits/25308/> Using textual
analysis

\-
[http://www.institutionalinvestor.com/Article/2593339/Markets...](http://www.institutionalinvestor.com/Article/2593339/Markets-
Exchanges/Inside-the-Machine-A-Journey-into-the-World-of-High-Frequency-
Trading.html) Article on HFT

\- <http://news.ycombinator.com/item?id=1517339> Ask HN: Is it feasible to do
high-frequency trading as an individual?

\-
[http://www.reddit.com/r/IAmA/comments/9s9d7/iama_100_automat...](http://www.reddit.com/r/IAmA/comments/9s9d7/iama_100_automated_independent_retail_trader_i/)
I bootstrapped an automated trading firm ama

\- <http://quant.stackexchange.com/>

\- <http://bitstat.wordpress.com/>

------
gaika
Don't ask who is losing on the other side of your trades but think instead who
is your customer. What is the service that you provide and how it helps them.

If you're making a profit it means you bought inventory when the price was
below fair value (your customers didn't need it and wanted to sell as fast as
possible) and you sold it when the price was above (your customers really
needed the shares right now). The net benefit to everybody is that the
volatility is lower, as you moved the price down when it was too high and
moved it up when it was too low.

The market efficiency is higher too: a lot less capital is required to
establish fair prices as market reacts immediately to any imbalance.

It also makes the spread lower and makes buying and selling stock cheaper for
your customers. Only a few years ago market makers and specialists would
chicken out at the first sign of trouble and would widen the spread between
bid and ask prices. Crossing the spread is a huge part of your overall expense
of trading. Unfortunately very few investors understand full impact of it on
their returns and don't appreciate your contribution.

Execution time is better now. Even during flash crash it was possible to buy
and sell with retail brokers, where's I still remember times in 2001 when
retail broker market orders sometimes took minutes to fill.

~~~
veyron
"If you're making a profit it means you bought inventory when the price was
below fair value (your customers didn't need it and wanted to sell as fast as
possible), and you sold it when the price was high (your customers really
needed the shares right now)."

It's a bit more complicated than that, because it's fully possible that the
seller in a trade is selling above his fair value and the buyer in that trade
is buying below her fair value. Supply/demand certainly plays into it (a
trader with a very large position is definitely willing to take some price hit
if they are able to quicky their position), which will invariably lead to a
discussion of utility functions and slowly bore everyone :P

~~~
gaika
> invariably lead to a discussion of utility functions and slowly bore
> everyone

But that's the crux of the matter - both sides of the trade are getting some
utility gain (otherwise the trade would not happen) and thus it is not a zero
sum game.

It is still zero sum in short term dollars, which just obscures the subject
for the people who equate utility with dollars.

~~~
CJefferson
No, they are not getting utility gain.

Recently I was selling an netbook, aiming to get about £100. A friend told me
she was wanting something, and looking to spend about £150. We split the
difference and went £125.

It would not have been a utility gain if someone had quickly jumped between
us, given me £100, sold the laptop to her for £150 and kept the £50 for
themselves. We would both have ended up out of pocket.

The whole point of exchanges is that they connect buyers and sellers.
Parasites living making a living by being faster than anyone else are not
helping anyone.

If there was a level playing field, and everyone went at the same speed, and
they could still make money, then I could believe they were adding some
utility.

~~~
gaius
It's more subtle than that. If you wanted to make the sale _now_ and your
friend wanted to buy next week when she got paid, then an intermediary _would_
be adding value, purely by being willing to act more quickly. The difference
would cover them sitting on the laptop for a week.

~~~
CJefferson
High-speed traders are living in the millisecond range. Do you think the
people doing trading on the order of seconds are pleased they are paying to
save milliseconds or not? I suspect not, but would be happy to be proved
wrong.

~~~
danvet
What would really happen is that a second trader would enter the market, offer
to buy the laptop for 110$, hold onto it and then sell it on for 140$. Actual
prices vary and with enough competition, will settle to something that gives
the trader still a nice profit and enough cash to insure against the risk of
such an operation (the trader doesn't know up-front when he can actually
onload the goods and how far the price might move meanwhile).

Of course, if you're not desperate on selling right now and or the risk for
the trader is too high (i.e. the minimum price you'll sell right now is higher
than what the trader is willing to offer you right now), nothing happens.

Concluding, traders do add utility to a market. And as others have already
said, with high freq trading it mostly results in massively reduces spreads
(and the temporal utility as outlined in the laptop example essentially
disappears).

------
sthatipamala
Is it feasible to apply these basic HFT principles to the Bitcoin market? I
assume it would be easier than the "real" markets because you aren't competing
against the big players.

~~~
sthatipamala
Wow, downvotes for asking a question?

------
joshu
The first example is called "pairs trading". Try extending out the math to
multiple sets.

I once wrote an ADR arb detector, which even took into account the forward
contract for the currency trade.

------
epaulson
This is fun reading. It reminded me of another blog, "WK's High Frequency
Trading Blog" (howtohft.wordpress.com) which got about 9 posts in with some
great details, and then went silent.

I found it in my Google Reader feedlist, and the last post was from March, but
Wordpress now says the blog has been deleted. Anyone know what happened it?

Veyron, I'm glad you're writing these posts. It's cool to have HFT
demystified.

~~~
vitobcn
No idea what happened to it, but I found this backup if anyone is interested:

<http://www.opensourcetrader.com/author/wk-selph/>

------
allenbrunson
115 days ago, you posted that you had quit your job and struck out on your
own. Is this the project you've been working on since then?

~~~
veyron
A friend and I built an iPhone app in pursuit of a new concept, and we did a
few field tests, but Apple did not approve the app. At that point, although we
could have continued pushing, we decided it was easier to stop the project and
part ways. I decided I didn't want to go back and work for someone else (blame
HN for being bitten by the startup bug :)

------
getsat
These are great! Keep posting 'em! :)

I'm more interested in the tech than the economics, but it's still a good
read.

~~~
veyron
someone left a comment in the first post saying: "... most of the crowd here
probably comes from HN and as techies we don’t have much knowledge of the
trading part of HFT."

I assure you, it's in the pipeline.

~~~
getsat
Understood. Thanks again for publishing these!

------
known
You can buy off the shelf HFT solution from
[http://www.stoneridgetechnology.com/products/pci-e-
developme...](http://www.stoneridgetechnology.com/products/pci-e-development-
boards/hft-development-kit/)

~~~
veyron
There are all kinds of companies selling technology solutions for everything
(as targeted as FPGA-driven feed data processors; as all-encompassing as the
solution you presented). Most of them are crap and oftentimes have no paying
customers. Hopefully, I will be discussing the state of the financial tech
industry in a later post.

------
maximilianburke
What services would you use for executing the trades?

------
helwr
related: <http://code.google.com/p/disruptor/> ,
<http://martinfowler.com/articles/lmax.html> , <http://www.quantcup.org/> ,
<http://quant.ly/>

------
orenmazor
I don't know why I wrote this field off as boring several years ago. This is
absolutely fascinating (from a technical perspective, I mean)

