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January 1, 2013

Speed Kills

Father of Algorithmic Trading Seeks Controls

By Gregory Bresiger

Interactive Brokers founder Thomas Peterffy started the practice of sending coded instructions from a broker's computer to an exchange's terminal, using a typing cyborg. Now, he believes several "layers" of software are needed in the securities industry's infrastructure to control high-speed trading.

Interactive Brokers founder Thomas Peterffy is an inadvertent provocateur. He started the computerized trading revolution in the 1980s, without that intention.

Thomas Peterffy

By trial and error, Peterffy figured out how to hack into market data feeds, with crude computing technology by today's standards. He even used, in effect, a "trading cyborg," with keyboard-pounding fingers, to type orders more rapidly than any human on the street.

In the process, he kicked off the use of algorithms, which now account for roughly two-thirds of all trading in the nation's stock markets. Now, he says, some three to five "layers" of controls need to be placed on the computerized trading he is credited with launching a quarter century ago.

Peterffy is, in effect and reality, the father of algorithmic trading. Here's his story. And his recommendations about how to manage markets where all trades, eventually, are handled by coded instructions.

Peterffy took "the brains of the smartest traders and found a way to express those smarts in a series of algorithms. His programming included all the elements that a crack human trader weighed in making a decision," writes Christopher Steiner in the book "Automate This: How Algorithms Came to Rule the World."

That starts off chronicling Peterffy's attempts to hook desktop computers into the digitally driven operations of electronic markets. "[T]he computer took far less time to do the math, check the prices and pull the trigger."

The Hungarian immigrant began as a black-box programmer on Wall Street in the 1960s. About a decade later, starting his own business, Peterffy ran afoul of Nasdaq, when he tied an IBM computer to the terminal that brought in quotes from that market and into which new orders were fed.

In effect, he had hacked into the terminal to get its data on trades as they took place and used hardwired connections back to the terminal to pump in orders, by mathematical rules.

This was the first fully automated algorithmic trading system in the world, Steiner notes.

But lashing a computer to its terminal violated Nasdaq rules that required orders be typed into the terminal one by one. The self-regulating organization told him to unhook the wires from the Nasdaq terminal.

So Peterffy took a different tack. He disconnected the IBM computer.

Then he and his team of engineers affixed a large lens to the face of the Nasdaq terminal. That enlarged the text it displayed.

A foot away, a camera took in the data and fed it to an attached computer.

Then the data was decoded and plugged into the group's algorithms.