Speed of transactions in algorithmic finance

Markets suffer from congestion when there isn't enough time to make or evaluate all the offers that participants want to make. Even markets in which offers can be made very quickly can suffer from congestion, as I discovered years ago when I studied a labor market with about a six minute turnaround time between getting an offer rejected and making a new one.

In financial markets, the time required to make an offer is sometimes called the latency time, and it apparently can never be short enough: The New Speed of Money, Reshaping Markets

"In this high-tech stock market, Direct Edge and the other exchanges are sprinting for advantage. All the exchanges have pushed down their latencies — the fancy word for the less-than-a-blink-of-an-eye that it takes them to complete a trade. Almost each week, it seems, one exchange or another claims a new record: Nasdaq, for example, says its time for an average order “round trip” is 98 microseconds — a mind-numbing speed equal to 98 millionths of a second.

The exchanges have gone warp speed because traders have demanded it. Even mainstream banks and old-fashioned mutual funds have embraced the change.

“Broker-dealers, hedge funds, traditional asset managers have been forced to play keep-up to stay in the game,” Adam Honoré, research director of the Aite Group, wrote in a recent report.

"Even the savings of many long-term mutual fund investors are swept up in this maelstrom, when fund managers make changes in their holdings. But the exchanges are catering mostly to a different market breed — to high-frequency traders who have turned speed into a new art form. They use algorithms to zip in and out of markets, often changing orders and strategies within seconds. They make a living by being the first to react to events, dashing past slower investors — a category that includes most investors — to take advantage of mispricing between stocks, for example, or differences in prices quoted across exchanges.

"One new strategy is to use powerful computers to speed-read news reports — even Twittermessages — automatically, then to let their machines interpret and trade on them.

"By using such techniques, traders may make only the tiniest fraction of a cent on each trade. But multiplied many times a second over an entire day, those fractions add up to real money. According to Kevin McPartland of the TABB Group, high-frequency traders now account for 56 percent of total stock market trading. A measure of their importance is that rather than charging them commissions, some exchanges now even pay high-frequency traders to bring orders to their machines.

"High-frequency traders are “the reason for the massive infrastructure,” Mr. McPartland says. “Everyone realizes you have to attract the high-speed traders.”