How to artificially slow down a stock exchange?

This article explores how an exchange called IEX uses a simple solution which uses physics to deal with the price information advantage that HFT firms have over retail traders.

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Like back in the old days, a modern stock exchange isn't people yelling at each other to buy and sell things. It's a matching engine, a computer system that takes in all the information of who wants to sell, who wants to buy, and what prices they want, and then pairs them all up, and exchanges money and shares automatically as fast as it can.

Over the last couple of decades, though, something called high-frequency trading (HFT) appeared. HFT is basically using computers to trade on a stock exchange, faster than any human ever could. They watch for price fluctuations and react instantly before anyone else can. The faster they react, the more money they can make. So, companies collectively spent billions on moving their equipment closer to or even inside the exchange, or building private microwave and cable links that send signals faster than anyone else.

One of the strategies HFT firms use is to see someone else send a trade request and then get the same offer to the exchange faster, buy the shares first, and then sell them back to the original buyer for a tiny, tiny profit billions and billions of times. Each microsecond advantage could mean more profits. These days, so many companies have spent so much money to get those tiny speed gains that they're all trapped in a stalemate. They're all as close to the exchanges as they can be, and the signal routes are as close to light speed as they can possibly make them. When everyone's bought the same expensive advantage, no one's in the lead.

There is another solution, though, and it's being used a stock exchange called IEX . IEX is a fully-fledged stock exchange, just like New York Stock Exchange and NASDAQ. They have used a novel technique in order to deal with the advantages that HFT firms have over human traders. The only way to do that, as an exchange, to slow things down. In the US, all the exchanges are obligated to know what's going on in every other exchange. So, they connect to all the other exchanges and take in super-fast feeds, and make a determination on the best price at that time. If someone can take in that information quicker than the exchange they're trading on, then they can pick off people trading on that exchange before the exchange even knows what the new price is.

IEX deals with this problem by introducing an artificial delay of 350 microseconds for everyone who trades on the exchange. So, they take in all the data and make a determination on what the fairest price is, and as long as no one is 350 microseconds faster than IEX, they will always have the clearest snapshot on what the true price is in the market. IEX artificially introduces this delay due to something called propagation delay. it just means the further away you are from the signal, the longer it takes you to get it.

So they thought, we introduce distance? 350 microseconds equates to 61 kilometres of travel time. They called up a fiber-optic provider and asked them to coil spools of cable equalling 61 kilometres in length and anyone who wants to trade on IEX has to traverse this distance. The high-frequency traders are fast, but because physics is physics, so they'll never be 350 microseconds faster than the exchange. This ensures that they are able to provide their clients with the fairest price.

Spools of fiber optic cable which is used to introduce an artificial delay

But, this kind of innovation did not come without its detractors. The IEX filing to become a stock exchange was the most controversial filing ever. There were speculations around introducing an artificial speed bump in the market which could lead to calamity in the markets. However, in the end they got approved. Two years later, the SEC put out a white paper saying not only did the calamity not occur in the market, the market overall, not just IEX, has been more stable since IEX became a stock exchange.

Do we need such artificial delays in BSE and NSE in order to make things fairer for retail investors? Some food for thought.