OUCH! Another High Speed Enhancement
Today, we would like to tell you about yet another stock exchange product which will allow even faster order entry into the market for certain customers. Before we let you know what it is, we think it’s important that we explain two terms that the Nasdaq Stock Market uses:
This is NASDAQ’s proprietary data feed. It distributes all levels of orders with attribution, trade messages, net order imbalance data, administrative messages and event controls. The feed is available in both a software and hardware (FPGA) version.
OUCH is NASDAQ’s order entry protocol. According to Nasdaq:
“OUCH provides customers with a fast and highly efficient way to connect to Nasdaq, BX and PSX. This protocol allows subscribers to quickly enter orders into and receive executions.”
(Ironically, ITCH and OUCH were actually developed by Josh Levine of Island. According to Scott Patterson’s book “Dark Pools”, “ITCH and OUCH didn’t actually stand for anything. They were intended to make fun of Nasdaq’s proclivity toward using four-letter conventions such as NQDS, Nasdaq Quotation Dissemination Service.”)
In July of this year, NASDAQ announced plans to introduce Field Programmable Gate Array (“FPGA”) technology on the Nasdaq order entry port and gateway servers, including Dedicated OUCH.”
In their SEC proposal, Nasdaq stated:
“The enhanced ports will use field-programmable gate array (“FPGA”) technology, which is a hardware-delivery mechanism and an upgrade to the existing software and software-and- hardware based mechanisms. By taking advantage of hardware parallelism, FPGA technology is capable of processing more data packets during peak market conditions without the introduction of variable queuing latency. In other words, the upgrade to FPGA will improve the predictability of the telecommunications ports and thereby add value to the user experience.
The Exchange continuously strives to offer members state of the art technology to enhance their trading experience and thereby enhance the national market system. In addition, the FPGA enhancements will provide value to members far exceeding the incremental costs imposed.”
For high speed traders, this hardware-based enhancement gives them a distinct advantage since they have more certainty with the entry of their orders during times of market stress. For everybody else, this was a meaningless enhancement.
But something happened on the way from proposal to production. In September of this year, NASDAQ had to roll back this proposal when they discovered a potential problem:
“NASDAQ recently completed internal testing of future functionality related to the trading systems and through this testing identified a potential unforeseen risk, which could cause a disruption to trading with the FPGA updated ports. As a consequence, the Exchange has determined that the risk associated with keeping the FPGA technology in terms of potential disruption to trading outweighs the benefit provided in terms of increased performance.”
We’re glad that Nasdaq did the prudent thing and stopped the rollout. As we have seen in the past, software/hardware enhancements that are not tested properly have the ability to cause major disruptions in the market and potentially cost millions of dollars.
Nasdaq must be now confident that they have fixed the problem and last week announced that they will be reintroducing this FPGA technology:
“Nasdaq plans to re-introduce Field Programmable Gate Array (“FPGA”) technology on all Nasdaq order entry port servers, including Dedicated OUCH. By taking advantage of hardware parallelism, FPGA technology is capable of processing more data packets during peak market conditions without the introduction of variable queuing latency resulting in more consistent, deterministic behavior.
Latency reduction. It’s always seems to be about latency reduction when it comes to exchanges selling products. This shouldn’t surprise us since exchanges make most of their money from data related services.
Exchanges like Nasdaq, who we liken to arms merchants, have long said that there high speed services such as Dedicated OUCH ports, colocation and proprietary data feeds are available to all market participants. They like to boast that “anyone can purchase these services”. But in reality, the cost of a full, high speed setup is prohibitive to most investors. However, those that pay for these high speed services get to enjoy an unfair advantage when it comes to market access. The fast traders continue to exploit the slower traders while Nasdaq encourages and profits this behavior.
It’s obvious to us that exchanges are locked in an arms race and will continue to provide more and more services that shave off a few more microseconds. Their customers, who have business models that center around speed, will be forced to buy these services to compete with their high speed rivals. And the lower speed, traditional investors will continue to be disadvantaged.
We have long believed that the only way to stop this madness is for regulators to step in. The SEC’s mission statement says:
“The mission of the SEC is to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation.”
What value does a Dedicated OUCH port with FPGA technology bring to investors who are not focused on shaving microseconds off their order entry? How does a Dedicated OUCH port with FPGA technology facilitate capital formation? And more importantly, is the SEC monitoring this new technology to make sure it doesn’t go haywire and cause damage to long term investors?
In her June 2014 speech on equity market structure, SEC Chair White questioned the benefit of low latency strategies to long term investors:
“Do low-latency tools, even though they are available to investors through brokers, tend to advantage certain types of proprietary trading strategies that may detract from the interests of investors? Some of the research suggests this may be the case. And a related fairness concern is the latency difference between the direct data feeds and the consolidated feeds.”
Unfortunately, regulators are moving at a snail’s pace and we don’t expect any action from them anytime soon on this issue. However, another alternative has taken shape recently. A disruptor by the name of IEX has entered the picture and has the potential, if approved by the SEC, to throw a wrench in this arms race. Approval of an IEX Exchange may actually let the SEC off easy since IEX may be the ones to step in and stop the arms race.