Winning Isn’t Just About Being Faster, It’s About Being Better

 
Goodbye Trading Pit – Hello Computer
No matter how the participant selected their trades, all of these trades were matched in trading pits. However, from the mid 1980s, trading pits around the world began to close in favour of electronic trading systems that claimed to be cheaper and more efficient for the investors.
The traders themselves did not necessarily want the change, as one Asia-based prop trader stated, more technology was the “doomsday” scenario for traders; they loved the floor and wanted to stay there. However, as highlighted by one European hedge fund manager, if one were to look at the data correlating the advent of faster electronic trading versus returns, there would be a positive correlation.
In the same way as hand signals improved the speed of communication, the electronic market was just another means of communication, and of benefit to all investors. But, no one imagined that the by-product of the matching engine, the audit trail of prices, would play such an influential role in the development of modern markets.
Technical analysis has been in use since the 1920s, and together with this new source of high quality data, it made sense to apply computing power to these calculations. This data was reliably and quickly available on every tick of the market; in short the trading engine was born.
In the brave new world of electronic exchanges, each exchange believed that in differentiation, not uniformity, lay the path of progress. Acting on this produced proprietary exchange interfaces. Differences extended all the way to regulations that treated securities and derivatives differently, and of particular importance were the rules that governed certification to the exchange interface.
In the equity world it was initially the exchange and some independent software vendors that were granted access to the exchange interface. Brokers developed their own internal order management and routing capabilities. The brokers provided services to clients, and the execution services eventually morphed the order routing technology to auto-accept orders, and then into direct market access and broker algorithms.
While there are similarities in derivative exchanges, there are some significant structural differences. Derivative contracts are uniform, and may be given up to a clearing broker. Many participants chose to be a non-clearing member, but retained the right to connect into the exchange interface.
Exchange connectivity was an ordinary infrastructure decision to many. However, to the trading firms that were experimenting with trading engines, decisions as to ‘how much’, and ‘on what’ to invest for their exchange connectivity infrastructure was strategic.
 
Evolutions in APIs, and messaging languages such as the FIX Protocol, have also meant that the speed and accuracy of communication have greatly increased. As a Londonbased hedge fund manager said “FIX was like the glass wall in the restaurant, it allowed you to see when the chef dropped the steak.”
As such all of the elements were in place to allow for the rapid development of automated trading, all that was needed was an environment to breed the change.