How Do High Frequency Traders Make Money

High-frequency stock traders turn to laser networks, to make yet more money

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A laser network, in Stuttgart

If you thought that stock traders made enough money, and wielded enough power over the global economy, think again: Financial traders are now turning to high-speed laser networks between stock exchanges, to decrease latency by a few milliseconds, to squeeze a few more trillion dollars per year out of high-frequency trading (HFT).

If you haven't heard of high-frequency trading before, it's essentially the automated, algorithmic buying and selling stocks. HFT is performed by computer systems that are attached directly to stock exchanges. These HFT computers are armed with algorithms devised by the finest brains in the world (really), which constantly scan the market for securities (stocks) that can be bought low on one exchange, and sold high on another exchange, usually netting just a fraction of a cent per trade. Do this thousands or millions of times per day, though, and HFT can make a lot of money. Furthermore, by improving the speed and accuracy of the algorithm, traders can make billions — by having a lower-latency link to the stock exchange than their competitors, a financial firm can make trillions.

A beautiful microwave tower Which leads us neatly onto low-latency network links. Over the last decade or so, as HFT has become the predominant way of trading stocks, the focus has been on low-latency fiber-optic links between exchanges. As we covered last year, there are currently three cables being laid between the London and Tokyo, which will reduce the latency from 230ms to 170ms — at a cost of $1.5 billion. There is also the Hibernia Express trans-Atlantic cable, which will cut the round trip between New York and London by six milliseconds (to ~59ms), at a cost of $300 million. While the added redundancy of these new links is nice, the biggest customers are expected to be financial traders who stand to make millions from the lower latencies.

There's a new network topology craze, though, that can drop the latency even further than fiber optics: Free-space microwave networks, and soon free-space laser links. Perseus Telecom recently completed a microwave link between London and Frankfurt that reduced the round-trip latency to just 4.6 milliseconds — almost halving the 8.35-millisecond round-trip for the London-Frankfurt fiber link. Perseus' network is essentially a series of microwave dishes strapped to towers (pictured right), forming as straight a line as possible between London and Frankfurt. By cutting the distance traveled, and not having to jump through possibly-congested routers, latency drops dramatically.

The microwave network cost between $13 and $26 million to build, but for the financial trader who uses it could earn billions. Curiously, though, we only know about Perseus' microwave network in the first place because a competitor launched a rival link in February; in the world of HFT, where financiers can win or lose depending on their link latency, secrecy is key. It's also worth noting that microwave networks are fairly old hat: Telecom companies have used microwave links between cell towers and phone exchanges for decades — but because they're affected by weather, and they have low capacity, they've been phased out in favor of fiber-optic links. It is because of these inherent weaknesses that HFT can't rely solely on microwave links: It would be a most unsatisfactory if a bit of drizzle in London halted trading.

Which is where lasers come in. According to AOptix, its laser network technology has the reliability and capacity of fiber optic networks, and the low latency of microwave networks. AOptix started off as a US defense contractor, creating a laser-based system that allows for 10Gbps air-to-ground networks over a distance of 200 kilometers (124 mi). Now it wants to bring this technology to the consumer market, supercharging mobile backhaul links (connecting carrier towers to each other, and to the main backbone) and financial trading. By combining adaptive optics and beam steering (to account for swaying towers), AOptix says its laser links work in all weather conditions. AOptix hopes to roll out some short-range laser links in the US and UK, and then follow up with a London-Frankfurt laser link in the future.

What about longer wireless links, though? If London-New York could have its latency halved like London-Frankfurt, it would be a revelation in high-frequency trading. Mike Persico, CEO of Anova — AOptix's partner in the venture — says that barges or drones might be used to create a cross-Atlantic laser network. Drones with high-powered lasers. What could possibly go wrong?

Now read: The secret world of submarine cables