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March 7, 2008

Speed of Trading Leaves Some Traders Behind

By Peter Chapman

The speed of trading is getting so fast that trading in microseconds is expected to soon become a reality. The trend promises to benefit some traders at the expense of others.

With algorithmic traders demanding faster turnaround times, exchanges and ECNs are beefing up their trade processing capacity. Turnarounds under 10 milliseconds are fast becoming the norm, and exchange officials predict the numbers will go even lower.

"We are all heading to microseconds," Andrew Brenner, head of the ISE Stock Exchange, a subsidiary of the International Securities Exchange, told a group of traders last month. "To be even a player in this game, you have to be in the single-digit milliseconds and you have to go down from there."

The turnaround time for an order or a cancellation is the time it takes for the message to reach an exchange or ECN plus the time it takes for a report to be sent back to the trader.

Turnarounds are measured in milliseconds; a millisecond is one-thousandth of a second. With turnarounds approaching one millisecond, traders will have to start thinking in microseconds. A microsecond is one-thousandth of a millisecond. That means there are 1 million microseconds in a second. "People talk about sub-10-millisecond round-trips," James Kearney, a senior vice president of business development for the National Stock Exchange, said at the annual Security Traders Association of Chicago (STAC) conference in January. "Two years ago, that would've been thought of as incomprehensible. Now it's just a given."

Accompanying the increase in speed is an increase in message-traffic volume. Largely because of Regulation NMS, exchanges must cope with a surge in trade messages.

Market centers, Kearney says, cope with 208 million messages per day in Tape A, or New York Stock Exchange-listed, securities, up from 22 million in 2005. Back then, one trade occurred for every four messages. Today the ratio is one trade for every 17 messages. The speed of trading is leaving some behind. Traders that take quote and last-sale data direct from the self-regulatory organizations, or market centers, have timelier information than those who rely on securities industry processors (SIPs) for data.

"The SIPs right now are between 30 and 40 milliseconds behind actuality because of latency in the lines," Kearney noted. "We see that every day. People try to hit our quotes that aren't there anymore." The two major SIPs are the Securities Industry Automation Corporation, or SIAC, which is owned by the NYSE, and Nasdaq.

Dave Herron, Chicago Stock Exchange chief executive, agrees that latency is an issue. "There are many people trading with market data that is hopelessly behind what other people have," he told the STAC crowd.

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