Monthly Archives: March 2008

Uncovering Time in the Financial Markets – Time of the Trade

Previously I listed examples of how small intervals of time are deeply rooted in modern electronic trading strategies and regulations. Although the process of buying and selling stocks, whether in a manual environment involving specialists on the floor of a major equities exchange, or in an automated environment involving two systems with complex decision rules for valuating and purchasing stocks, has significantly changed over the centuries, the outcome remains the same – to enable the exchange of shares (equity) of ownership, for a particular company, between a buyer and a seller at some agreed upon price, this is fundamentally the process of trading in the equities markets.

It is within this process that regulators and trading organizations have become incredibly sensitive to even the smallest measures of time. The trading process can be broken down into the following steps. First is the specification of the order details (eg. price, symbol, size) from the buyer or seller followed by the acknowledgment of that order by a trading venue such as an exchange, ECN, or broker dealer. The order is then optionally routed to one or more venues that will execute the trade by matching it with a counterparty order before reporting the details of the execution back to a trade-reporting facility.

Vendors, regulators, data providers, and marketers of trading technology mislead when quoting microsecond, millisecond or any temporal measures by failing to describe the inherent inaccuracies of such measures in a distributed systems context. Because the trade process described above is fundamentally distributed across machines whose concept of time is largely subjective, a measured interval of one second between any nodes in this trading process may amount to significantly more or less than one second when measured on the scale of an atomic clock.

To ensure that regulatory or strategic measures of time, are in fact accurate, it is necessary to create a single global understanding of time between related machines. Clock synchronization refers to the problems caused by clock skew and jitter, and the solutions that enable a common, more accurate understanding of time, albeit with built in margins of error.

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Uncovering Time in the Financial Markets – Law & Profit

As I mentioned, the measure of small intervals of time, in the financial markets, is deeply rooted in both modern regulatory policies as well as electronic trading strategies. The SEC, FINRA and other industry regulators have innovated their way towards temporal constraints that reflect the lightening speed of today’s electronic trading landscape. On the business side, the continuing arms-race towards low-latency algo trading platforms is built on the premise that profit comes to those who discover and trade the best available price first. With milliseconds and now microseconds separating competing trade requests, industry participants are paying huge premiums for technology that promises even the smallest temporal improvements over competitor offerings.

Regulatory Time

Here is just a small sampling of the temporal references found in today’s electronic-trading compliance requirements:

FINRA Trade Reporting:

…transactions that are subject to NASD Rules 6130(g) and 6130 (c) and also required pursuant to an NASD trade reporting rule to be reported within 90 seconds.

SEC Regulation NMS Self-Help:

If a market repeatedly does not respond within one second or less, market participants may exercise “self-help” and avoid that market for purposes of the Order Protection Rule.

OATS Reporting

…Order Sent Timestamp (date and time) is within +/- 3 seconds

SEC Regulation NMS Intermarket Sweep Order Workflow

Answer: Yes, waiting one full second to route a new ISO to an unchanged price at a trading center would qualify as a reasonable policy and procedure under Rule 611(a)(1) to prevent trade-throughs.

SEC Regulation NMS – Flickering Quote Exemption

In addition, Rule 611 provides exceptions for the quotations of trading centers experiencing, among other things, a material delay in providing a response to incoming orders and for flickering quotations with prices that have been displayed for less than one second.

SEC Regulation NMS – 3 Second Quote Window

To eliminate false trade-throughs, the staff calculated trade-through rates using a 3-second window – a reference price must have been displayed one second before a trade and still have been displayed one second after a trade.

At best these temporal references serve as explicit requirements that drive the necessary software decisions to stay compliant. However, interpreting these time-intervals without considering the distributed nature of the trade-lifecycle and the ambiguity of time in this context, can lead to misinterpretation and confusion.

Profit Time

Similarly, on the business side, there is an unprecedented awareness and profit-sensitivity to small time intervals. Here are some quotes from industry stakeholders:

Chicago Mercantile Exchange

“Traders using CME Globex demand serious speed. If the network is even a few milliseconds slower than 40 milliseconds of response time, they don’t hesitate to notify CME.”

Philadelphia Stock Exchange

“The standard now is sub-one millisecond,” said Philadelphia Stock Exchange CEO Sandy Frucher. “If you get faster than sub-one millisecond you are trading ahead.”

Investment Banks

“Firms are turning to electronic trading, in part because a 1-millisecond advantage in trading applications can be worth millions of dollars a year to a major brokerage firm.”

The TABB Group

“For US equity electronic trading brokerage, handling the speed of the market is of critical importance because latency impedes a broker’s ability to provide best execution. In 2008, 16% of all US institutional equity commissions are exposed to latency risk, totaling $2B in revenue. As in the Indy 500, the value of time for a trading desk is decidedly non-linear. TABB Group estimates that if a broker’s electronic trading platform is 5 milliseconds behind the competition, it could lose at least 1% of its flow; that’s $4 million in revenues per millisecond. Up to 10 milliseconds of latency could result in a 10% drop in revenues. From there it gets worse. If a broker is 100 milliseconds slower than the fastest broker, it may as well shut down its FIX engine and become a floor broker.”

Brokerage House

“Arbitrage trading is critically dependent on trading off valid prices and getting the orders in as fast as possible without overwhelming the exchange gateway and so latency on the market data stream and order entry gateway capacity is a big issue.”

Chi-X/TransactTools Press Release

“TransactTools’ standard benchmark tests found that over 95 percent of messages sent to Chi-X were responded to in an average of 10 milliseconds…with the fastest response time being four milliseconds.  For high volume throughput testing, in which five million messages were generated in total, Chi-X maintained an average roundtrip latency of 18 milliseconds while handling 16,000 messages per second.  Chi-X’s internal latency, which is a measure of the system’s ability to process messages in its core rather than the roundtrip measurement, was measured by Instinet Chi-X at 890 microseconds, or less than one millisecond.”

Millisecond Marketing

With the industry’s increasing awareness to small time intervals, marketers are playing their temporal cards. Vendors of market data distribution platforms, high-performance messaging solutions, complex event processing and many of the other high-performance technologies on Wall Street can also misinform and sometimes disinform the capabilities of their offerings with respect to time and performance. Suggesting a vendor’s market data distribution technology offers millisecond or microsecond improvements over a competitors offering, without describing the testing context and particularly how clocks were synchronized in reaching the final measure is unethical. As high-performance trading technologies continue to commoditize, the pressure to show even the most minute temporal improvements will only increase.

Next I’ll describe the lifecycle of a trade request, and why measures of time in this context are inherently innacurate.

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Uncovering Time in the Financial Markets

In this era of low-latency, high-performance electronic and algorithmic trading, vendors, regulators and business strategist continue to misinform and sometimes disinform industry participants with references to time. Vendors, for example, can selectively manipulate their marketing campaigns to suggest dubious sub-millisecond advantages over competitor technologies. Regulators, who continue their ambitious drive to innovate for the twenty-first century industry changes, may get a bit ahead of themselves when not providing the appropriate clock synchronization context in quoting their temporal constraints. Investment banks and brokerage firms continue to preach the million dollar advantages of millisecond improvements in their trade lifecycle.

The widespread industry shifts in the financial markets have created an unprecedented and collective awareness and sensitivity to small intervals of time. The fact is that despite driving both regulatory and strategic policies, the quoted measure of these intervals remains another piece of misinformation and sometimes disinformation that misleads and confuses industry stakeholders.

In this three part series, I’ll first show examples of time’s importance from a financial market regulatory and strategic perspective. Second I’ll show exactly how and why this time is misinterpreted. Finally i’ll talk about how clock synchronization techniques can be used to better rationalize the measure of time across system boundaries.

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