ePigeons Test The Limits of Speed

(c) 03-05-07 john shepherdBy Christopher Faille

Despite what I am told is its gross simplification of history, an oft-told story about the making of a Rothschild fortune does manage to convey an important truth about one way to generate alpha.  In the spring of 1815, as political and military affairs pointed toward the final decisive engagement of the Napoleonic Wars, the financial world waited and wondered, and consols, a form of British government debt, stayed cheap.

On June 16, 1815, Napoleon’s left flank, under Marshall Ney, won a brief engagement with Anglo-Dutch forces at Quatre Bras.  Wellington fell back on Waterloo.  On the morning of June 18, the two opposing armies faced off again there.

Because of a network of agents and carrier pigeons superior in communications agility to anything else in the world, Baron Nathan Mayer Rothschild knew the upshot first.  He bought consols while all the other traders and speculators in London , and the government itself, still despaired at the now-misleading news of the loss at Quatre Bras, and many were eager to unload them.  The Baron’s foresight was of course vindicated by the running of the consol bulls when land-bound human messengers arrived from Wellington, and everyone knew what Rothschild had known for hours.

In due course, carrier pigeons and post roads gave way to telegraph lines, then telephones, then networks of computers.  In our own century automation has gone so far that actual human beings on an exchange floor seem destined to share the obsolescence of those pigeons.

Rule 15c3-5

Sometime in the first decade of the 21st century it became common for broker-dealers in the U.S. to offer certain customers “sponsored access” to the exchanges of which they (the brokers) were members.  This set up an intense rivalry among the different high-speed traders, with their ePigeon programs, each racing the others for the same fleeting opportunities.

In the developing jargon of software and networking gurus, they were seeking “low latency.”

In May 2010, the Dow Jones experienced its “flash crash,” and though the market recovered quickly, regulators didn’t.  Out of their angst has come the Securities Exchange Commission’s rule 15c3-5, a rule that requires that the broker who sponsors direct access by a customer to an exchange remain in the loop.

This certainly isn’t going to turn the pages of history backward to a simpler, slower time.  Nobody in 19th century Britain even thought to demand that the Rothschilds start using slower pigeons, or rely on messages by horse-pulled post.  Trading technologies have progressed from marking their difference in seconds, to marking those results in milli- and microseconds.  The nanosecond as a selling point seems inevitable.

But what do those words mean? Well,

A millisecond is 1/1000 of a second.

A microsecond is 1/1000 of a millisecond.

A nanosecond is 1/1000 of a microsecond.

Thus, a nanosecond is one billionth of a second, and is the unit at which personal computers’ internal speeds had come to be measured by the 1990s.

Rather, in the homey metaphor usually applied: this means that the broker-dealers can still lend their car keys to unlicensed drivers, but they have to stay in the passenger’s side of the car and watch the sponsored driver attentively.  This rule comes into effect in July, and it has forced such brokers to update their own equipment.

Design Components

In this context, the Stockholm-based concern Cinnober Financial Technology has issued a white paper on The Route to Single-Digit Microsecond Latency.

Single-digit latency means the transmission of a piece of data within less than 10 microseconds.  To a non-expert like myself, this sounds impressive.   A single one-way hop from brokerage firm to exchange (even if one is just down the street from the other) will amount to 1 – 2 microseconds, using the best hardware commercially available.  From there, data must be processed, so the software and network components of low latency take over.

In its white paper, Cinnober lists the following as critical design components:

  • A binary transaction protocol
  • The use of Remote Direct Memory Access, which eliminates network protocol stack processing
  • Preallocated data structures and
  • A highly streamline matching engine.

The white paper concludes, “The software is now so fast that the network is the new bottleneck.”  This is so especially if the software is written in Java, which Cinnober commends as “the language nonpareil for [meeting] aggressive time-to-market constraints.”

The Meaning Of It All

Most trades are now high-frequency, or low-latency, trades on one side or the other or both, as shown in the chart below.

High-Frequency Traders’ Dominance of NASDAQ Trading

HFTs Involved In a Trade

Trades %                                       Shares %                                      Dollar Amount %

High Frequency Trade              77.3 HFT




No HFT involved






HFT As Liquidity Taker

Trades %                                      Shares %                                      Dollar Amounts %













HFT As Liquidity Supplier

Trades %                                      Shares %                                       Dollar Amounts %













Source: J. Brogaard, “High-Frequency Trading and Its Impact on Market Quality,” Kellogg School of Management, Northwestern University, Table 4.

But does this sort of technological advance, the sort measured in microseconds, still produce alpha?  On one possible view, it is just a treadmill.  Each HFT firm has to buy the latest high-speed gizmos because its competitors have them, and the net effect is akin to that of the indebtedness incurred by competing nations in an arm’s race.

The Deputy CEO of Cinnober, Per-Anders Hall-Bedman, acknowledged the latter point.  “Probably at some point there will be a decrease in the marginal value of further advances [lowering latency] – there is of course a physical limit.  But I don’t think we’re there yet.”


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