the exchange will probably have trouble grabbing much of that business back. Hardware used at the facility will operate at a 40-gigabyte-per-second standard, enabling it to handle as many as a million messages a second. (The limit, in many cases, is not the speed at which the information travels but the ability of switches to route it quickly enough.)
The Tradeworx office in Red Bank, NJ, a wealthy shore town about an hour from Manhattan, is a far cry from Wall Street. A quieter place would be hard to imagine. About a dozen employees, most of whom graduated from top-tier schools with degrees in science, math, or engineering, work largely in silence. On this morning, as those 15 million shares come and go, the Tradeworx staff says hardly a word.
Cashing in: On a recent morning, Tradeworx bought and sold 15 million shares before noon.
In Narang’s office, the shades are drawn, the better to read a large monitor on one wall. There are no tickers scrolling by, no flashing updates on the value of the Dow Jones index. Narang’s strategy is “market neutral,” meaning that when it works–and it usually does–he makes money no matter which way the market goes. His profits don’t depend on whether share prices rise or fall; instead, he relies on a set of algorithms that can find and instantly take advantage of tiny, fleeting movements in trading activity. On the wall across from the window is a whiteboard filled with code: a scribbled flowchart in different colors, with variables and occasional amounts in boxes and the words buy or sell. In the middle of the monitor is a large number in a box, going up and down but mainly up. That is Tradeworx’s profit so far that morning.
A crash waiting to happen?
High-frequency trading has become controversial, with critics charging that traders are manipulating the market, taking advantage of the little guy, and even courting a full-scale financial meltdown. The critical voices are growing louder and more united, and they’re reaching higher up the rungs of power. In September, Senator Edward Kaufman (D-Delaware), speaking on the floor of the U.S. Senate, worried that the United States was moving toward a situation with “one market for huge-volume, high-speed players, who can take advantage of every loophole for profit, and another market for retail investors, whose orders are seemingly filled as an afterthought.” The Securities and Exchange Commission has recently proposed a rule to eliminate one controversial tactic of high-frequency traders: the “flash trade,” in which exchanges alert designated traders toincoming orders. Critics call it a variation of front-running, an old (and illegal) practice that involved traders buying and selling in advance of large orders.
But accusations of unfairness are not the only issue. Any trend that becomes as dominant as high-frequency trading should be studied to consider potentially serious side effects, warns Paul Wilmott, the publisher of the quantitative-finance journal Wilmott and the founder of the mathematical-finance diploma program at the University of Oxford. “High-frequency trading is the latest bandwagon, and everyone is jumping on board,” he says. “Wall Street always piles on to the next thing, and it always blows up.”
Wilmott, a self-described “instinctive contrarian” who correctly warned in 2000 that the derivatives market was dangerously unstable, sees particular threats from this trend. The increasing dominance of algorithmic trading and the growing speed of execution, he says, could cause tiny price changes to snowball, rolling down the hill at exponentially increasing speed–either because the machines are trading too fast or because too many funds are trading in the same style. “The potential is there for a crash to happen quite quickly,” he says.
Bernard Donefer, who oversaw electronic trading at Fidelity Investments from 1996 to 2002 and now teaches about information technology in financial markets at Baruch College’s business school in New York, worries that