By JACK HOUGH
Once-raucous trading floors in New York and Chicago are growing quieter every day. The real action now takes place in distant suburbs like Mahwah, N.J. and Aurora, Ill. There, in buildings twice the size of a Wal-Mart Super Center with power substations that could light small cities, NYSE Euronext (NYX)
Even inches matter to these customers, so much so that cables between servers are uniform in length to ensure information doesn't reach one tenant before others. For high-frequency trading firms that use powerful computers to pop in and out of positions in milliseconds, so-called collocation, or "colo," is a pricey necessity. That's because trade times are approaching the speed of light, and the only way to make light reach its destination quicker is to shorten the trip. CME Group, whose Aurora center is 80% leased and goes online early next year, is charging about $17,000 a month per server rack, almost six times more than the price of comparable data center space nearby, a source close to the matter told SmartMoney.com.
To some, collocation provides deep-pocketed firms a way to buy an unfair advantage. "When the exchanges were member-owned they looked out for ordinary investors, but now that they've shifted to a for-profit model they're taking care of their big customers," says institutional trader Joe Saluzzi of Themis Trading. "They've found a way to make money for doing nothing."
The exchanges say just the opposite--that they're making things fairer. If they didn't control server space, someone else would, says Joe Mecane, executive vice president of NYSE Euronext. "Then they would sell space to the highest bidder. It would go from a regulated part of the market to the Wild West."
Regulators have quickly imposed two broad restrictions on exchanges that sell collocation services. Prices must be reasonable and uniform and services must be made available to anyone who wants them. Hence, the giant data centers with plenty of room for anyone willing to pay the rent.
Even if access to that much speed is fair, it might still be harmful. The May 2010 flash crash, during which the Dow Jones Industrial Average plunged 900 points and recovered in minutes, prompted the Securities & Exchange Commission and the Commodity Futures Trading Commission to conclude in a joint report that high-speed computerized trading provides a false "hot-potato" liquidity that can disappear when investors need the support most, like during times of market stress.
High-speed trading now accounts for more than three-quarters of stock market volume, by some estimates. Advocates say the practice creates market liquidity, but it's unclear what the advantages of that are for ordinary investors, because high-speed traders tend to target the most liquid stocks.
Yale professor Frank Zhang studied data from 1985 to 2009 and found that the sharp rise in this kind of trading has brought some worrisome effects. Stocks with the biggest increases in high-frequency trading became significantly more volatile as a result. The practice also "leads to stronger price swings on things like earnings news," says Zhang. "Eventually, the effects reverse. That disconnect from fundamentals makes ordinary investors more likely to lose money at the expense of high-speed traders."
It might seem like these firms are raking in easy profits, but ironically, the extreme increase in speed means the gold rush is slowing. Firms have reached the physical and financial limit of being able to pay for faster trades, and what's left are a handful of players that have established their supremacy, says Paul Rowady, senior analyst with the Tabb Group, a research firm serving financial markets customers. The rest have a couple of choices. They can move to a less-developed market where newcomers can still gain lucrative speed advantages, like Singapore. Or, they change their strategies to ones that don't depend as heavily on speed.
That doesn't mean waiting around to collect dividends, says Rowady, but in might mean owning shares for minutes rather than milliseconds. Who says buy-and-hold is dead?
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