Since money first came into existence, some people have made gobs of it by having particularly timely access to important news. Perhaps the most notorious examples of this phenomenon took place during the first half of the last century in many U.S. cities. Here it was organized crime that profited immensely, and the news of interest was about horse races.
Initially, horse-race results were sent out over Western Union’s telegraph network, but when that company cut off this service to what it deemed shady customers, others with fewer scruples stepped in. On their private wires, race results were sent from the tracks to illegal bookmakers before the public at large learned of them, allowing bookies to accept bets on horses that had already lost and turn down wagers on horses that had already won.
For decades, bookmakers paid handsomely for those wire services, helping to support such notable Chicago mobsters as Mont Tennes and Al Capone. Access to a fast wire carrying breaking results from the track was an offer that bookies couldn’t refuse. A 1951 report of the United States Senate Special Committee to Investigate Crime in Interstate Commerce aptly notes, “The wire service is as essential to a book-maker as the stock ticker to a stockbroker.”
In today’s age of live sports broadcasts, bookmakers can no longer profit this way. But big financial companies that buy and sell stocks and other financial instruments with automated split-second transactions can—and do. The companies engaged in this relatively new practice, called high-frequency trading, are keenly aware of the importance of timely information about markets. And they use enormously sophisticated technology to wring out every last bit of delay—down to the microsecond level or even less—in getting that information and in executing their trades.
A few years ago, hundreds of millions of dollars were spent on a project to connect traders in New York and Chicago with an especially direct data link, and similar amounts are being invested now to hook up New York and London in the fastest possible way. These are just of couple of the most obvious investments in a multibillion-dollar game where advantages measured in millionths of a second can mean millions in profits.
“In the age of high-frequency trading, technological speed itself is a strategy,” says Benjamin Van Vliet, who teaches quantitative finance at the Illinois Institute of Technology’s Stuart School of Business. He likens high-frequency trading to picking up gold coins dropped on the ground—not much analysis or insight is required. Speed, however, is. “Whoever is fastest is going to win every time,” he says.
The buying and selling of stocks, commodity-futures contracts, and other financial instruments was traditionally a noisy affair, done by people calling out trades they wanted to make in the “pits” of various exchanges. Some of that still goes on, but most trading these days is done through the financial industry’s various electronic communication networks. These first sprouted up in the late 1960s and bloomed in the decades that followed. But until fairly recently, people largely remained in the loop, watching how market conditions were changing on their computer screens and pointing and clicking to execute their trades.
Increasingly, though, more sophisticated market participants have been using preprogrammed strategies to execute their trades, often splitting up their purchase or sales orders and submitting them at odd times so that nobody else can easily discern their overall intentions. That strategy helps to avoid driving up the price while you’re buying a lot of something or depressing it when you’re selling.
But such “algorithmic trading” is less useful lately, because the automated platforms that high-frequency traders have put in place over the last few years react so swiftly. “Whenever I wanted to trade some stocks, it seemed someone was looking over my shoulder,” says X. Frank Zhang of the Yale School of Management, who managed a US $500 million investment portfolio on Wall Street between 2008 and 2010 before taking his current academic post. “High-frequency traders could detect my patterns.”