When The Speed Of Light Is Too Slow: Trading at the Edge
kurzweilai.net
kurzweilai.net
As long as transactions weren't announced until the end of the period, there wouldn't be any benefit from microsecond advantages. And then stock trades would begin to go back to being based on the value of the stock, not what a model says it will do in the next 2 seconds.
I think it's a bug in the system that this arbitrage can even exist, though. It's not like, say, rice, the location of your shares doesn't matter.
If an exchange limits trading to every 10 seconds, then those trades will just happen privately between firms. So now the privately trading firms will know the "real" price of the stock, but the people on the exchange will be left it the dark with the "old" price.
Once you hit the the next allowed trading period, everyone is going to be selling exactly simultaneously, which will cause a nosedive in the price. Institutional investors like pension funds are legally obliged to sell shares if they go past certain trigger points, so if the nosedive cause them to get triggered suddenly you have a lot more selling and a market in panic.
Different people have different requirements for speed, and this naturally smoothes out trading, forcing everyone to trade at the same time is just asking for a disaster to happen.
Plus there's all sorts of other complications. For example order matching. There's one buy order and 100 sell orders. How do you decide which sell order to fill ? - you can't do it by time of ordering anymore, but you need a transparent way to ensure fairness. So you randomize it. But then your rewarding whoever manages to put the most orders in, so you need a way to fix that, and then fix the problems in that fix and so on and so on until you end up with a horribly convoluted opaque system.
And the market wouldn't be materially less efficient. The reason to have a market is to allocate resources towards effective producers by pricing them properly. Well, "no human could react quickly enough to buy the stock in New York and sell it in London before the prices reversed" means we know the market would inevitably correct that price even without the presence of that HFT. We are rewarding overinvestment in reaching price equilibria faster, when it already takes less time than it will for a producer to make any use of the money.
IMO. The main problem is that exchanges can't afford talented developers, they simply don't have the money to compete with the banks and hedge funds. Most exchanges have stop signals (i.e. a message they can broadcast that can stop computer trading, etc.) but often they fail to use them. Exchanges should be implementing algos to better detect abnormal behaviour (whether by human or computer) and prevent flash crashes before they happen.
Second, do you have any argument that isn't based on personal ignorance?
The stock market isn't even open at night, no one thinks that it is necessary to trade 20 times a second every second, they just want to. The stock market doesn't directly represent economic conditions, it represents investors assessment of economic conditions, thus it can change as fast as they can change their mind. If someone wants to only trade every ten seconds they can go ahead. If someone wants to open a stock exchange where everyone can only trade every ten seconds they can go ahead.
In the past the TWSE had a similar mechanism to the one you suggest: 30-second call auctions all day long (as compared to other exchanges who typically only had auctions at opening and closing time, and did continuous trading the rest of the day). Basically they'd give one best bid/ask update on a stock, gather new orders for a while (it was slightly random, sometimes as little as 22 seconds IIRC), match them at the volume-maximising price, and send out the new best bid/ask update. (Within this structure there was still time priority --- i.e. you only had to wake up once every 30 seconds, but when you did you had to send your new order ASAP. Also there was no atomic price amendment message ... you had to send an order delete and then an order create message, which caused all sorts of hilarity when they decided to take more than 30 seconds to send you a cancel acknowledgement.)
I read a study from 1998 basically supporting your position ... the authors concluded that "The call market method is more effective in reducing the volatility of high-volume stocks than low-volume stocks. This contradicts conventional wisdom which suggests that the call market method is superior for thinly traded stocks, while the continuous auction method is preferred for heavily traded stocks. The call market method does not impair liquidity and price discovery in the call market appears more efficient than in the continuous auction market." http://www2.hawaii.edu/~rheesg/Belgrade/Taiwan/TSEfinal.pdf
On the other hand, just a few months ago, the TWSE introduced continuous trading in response to pressure from exchange participants --- but only for warrants: http://www.twse.com.tw/en/about/press_room/tsec_news_detail.... http://www.twse.com.tw/en/products/trading_rules/mechanism01...
At this point I don't know yet of any detailed studies of the effects of that change. Also it's been years since I traded TW stocks, and I never traded TW warrants, so unfortunately off the top of my head I can't offer you an anecdotal account of the effects of the change either.
Now if you're a market maker it's very risky for you to offer a spread below 10pips because if the market moves by 10pips you're suddenly off-market and someone can arbitrage you by buying from you and selling on the market (taking a risk-free profit and pushing the loss onto you).
Now consider if the market was updating every 100ms and the price of EURGBP only moved by an average of 1pip every 100ms, it means you as a market maker can offer a 5 pip spread comfortable in the knowledge you can pull your price before an arbitrage situation occurs.
This lower spread you're offering is now available to your customers (who are likely to be other financial firms, big companies, and retail FX brokers). Because the retail FX brokers are getting a better spread they can offer a tighter spread to their retail customers.
This isn't just theoretical, FX spreads for retail customers (like folks going abroad or importing goods) are a lot tighter now than they were even a few years ago primarily because of faster trading.
The markets would trade at more "fair" prices (representing a a larger group of people) at slightly less frequency.
Vast sizes of stock ("block trades") already trade off-exchange in half-hourly crossings on posit, etc.
Hence the move to multicore.
Many of these optimal trading locations are in the ocean. The spar buoy based structures designed by the Seasteading Institute are directly applicable, as they are about the only seagoing designs that are safe for permanent habitation. (Immune even to rogue waves.)
At the minimum, there should be an expectation of the platform surviving the environment. Decoupling from wave energy is the point of a spar buoy. Even inanimate servers are perturbed by being smashed by walls of water. Did you actually read or search on anything mentioned, or did you just go with the "stead" in the name?
(As opposed to the 2 weeks on, 2 weeks off, hazard-pay situation people are in for offshore drilling operations.)
Consider currencies for example. Say someone in Tokyo was selling USDJPY at 84 and this was the best price anywhere in the world, then naturally anyone buying would want to buy from them. But the guy in London who wants to buy won't see the price of 84 until 90ms later, so he ends up buying from someone in New York at a worst price.
So the guy in London got a worse price and the guy in Tokyo didn't get a sale. Despite the fact that in an ideal world they would have been matched together, the fundamental laws of the universe conspire against them.
Essentially what ends up happening is that for any one currency you end up with a bunch of local market (NY, Tokyo, Singapore, London) all of which have slightly different prices from each other, which isn't a great situation to be in. Reducing latency won't make this problem go away, but it helps flatten out the markets and ensures that people get the best price globally (as opposed to just locally) wherever possible.
It's not as if people haven't tried other models, EBS who run one of the major currency exchanges restrict price updates to once every 100ms. They're losing customers to other exchanges who allow people to trade faster.
People with deep backgrounds in algorithmic game theory have been studying exchanges and auction design for a long time now. If someone could figure out a better design for exchanges, they'd be building it.
I'd like to read more about those attempts, if you have some pointers.
But potentially, a lower refraction index fiber with a reflective coating would allow signals to travel faster.
This research is patently academic. This is what happens when two pointy heads in ivory tower with zero empirical trading experience dream up something. Then all geeks go ga-ga talking about fiber optics and sea steading and other bs.
There is tremendous overlap amongst various stock exchanges, OTC's, dark pools (12% of US trading), and of course there's Forex which is 24/7.
But (as far as I understand) quantum entanglement doesn't let you transmit information at any particular speed, so that still doesn't work. (Roughly speaking, QE can be thought of as "the universe transmits information at >c", but in order to extract this information, we have to send messages conventionally. So it has a theoretical upper bound of c, like everything else, but has the same practical limits.)