I met people from several continents and many more cities, talked with Russians during the tensions between our respective countries and really began to appreciate things I would not have otherwise. Many of these people are now life-long friends, and they now crash with me for free. But I also began to think a lot about visitors versus locals.
More than a decade ago, “Judy” was a newly minted math major from a prestigious technical university. In 2006, “quants”, or quantitative analysts were in increasing demand at large investment banks. And they were willing to pay decent salaries with the potential of sky-high bonuses. In her graduating class, half of the technical people normally destined for graduate schools or research positions instead went to Wall Street.
The world of high frequency trading is a game with both fast and big stakes. Algorithms decide in milliseconds (if you’re slow) what price and where to send a stock option order. At her disposal at this employer was a team of PhDs in every imaginable domain — math, theoretical physics, computer science, and astrophysics. The investment in talent, computing power and infrastructure easily surpassed tens, if not hundreds of millions of dollars.
So it came as a surprise when she was tasked to go out to Chicago and determine what to do with their “legacy” floor operation. After a short plane flight, one of the first people she met was “Rex.” He serves as a broker on the floor of the Chicago VIX pit, which deals with anticipated volatility of the global markets. He also owns a boxing gym. He calls big city traders in NYC and helps them execute large transactions, finding the buyer or seller on the other side.
Chicago is a textbook example of Paul Krugman’s Nobel-prize winning Economic Geography theory. It’s a place that has natural advantages in trade of commodities and other goods, but it also just happened to be the place where people went and stayed. Network effects kicked in and it developed into a unique hub for commerce, just as Silicon Valley became a magnet for technical talent.
As made famous in the movie “Trading Places”, floor trading of these commodities and the massive profits that they produced were Chicago’s bread and butter. With corn and wheat, among many other staples flowing through this conduit city, futures and options markets thrived as traders would help take the risk and speculate on the prices of anything from gold to soy beans. These traders were called “locals”, and they arrived every day at the pit, knew each other well, and went on the business of making a living right before an early close of the market and an equally early drink.
As markets matured in the 90s, and telecommunication infrastructure created abilities to link what happened in Chicago to what might happen in New York — technologists took notice.
In a town, somewhere in the Midwest, a fiber optic trunk is needing to navigate a go-around due to a sewer line. It turns out photons at the speed of light, having to make a slight detour around inconvenient geography on the way to NYC is making the high frequency traders impatient.
Point to point microwave systems are the answer — why snake around at the speed of light when you can go in a straight line? Entire towers were leased or built for exactly this reason.
High frequency is not a bad thing, but it’s also not the most important thing. Should a trade take 30 minutes to execute, as it did in the 1980s? No — but how important is it when they are already being executed literally far faster than a blink of the eye? An entire generation of computer scientists, mathematicians, and engineers have been shaving nanoseconds from a process that no longer serves end customers, but only to beat their peer competition. This is, after all, why they were recruiting people with backgrounds like Judy’s.
The speeds for high frequency are racing to zero so quickly that at some point, fundamental randomness from quantum mechanics will be the final arbiter of who gets the trade first. This is a fitting technical endgame for an endeavor that, while highly lucrative, is ironically a waste of time. Impersonal speed also encourages different types of risks.
Perched on her trading desk in lower Manhattan, Judy was talking to Rex on the Chicago floor to execute a trade. She quickly realized she had made a mistake. In quoting a price for an option, she had reversed what she had actually intended. Rex had no issue with this and let her out of it. She saved money for her bank, and he maintained a relationship.
After moving to a new group within her firm that was attempting to build a high frequency trading business, Judy became alarmed at what she saw. Programmers pushing code were not showing up before the market open the next day to review and monitor the performance for any errors. In fact, it seemed that senior trading leadership had no idea of what things were being “pushed” to revise the codebase and the potential impacts. Later, she was fired for insufficient trading profits. The issues of code pushes were raised but ignored.
A few months after her dismissal, a relatively minor code change caused an unintended effect on the algorithms the following morning — nearly $100 million was lost within seconds. Tense haranguing with exchanges later that day as to which trades could be cancelled brought the total loss to “only” tens of millions. It begs the question — how can high frequency leverage a relationship to undo a mistake, in such an impersonal environment?
Walking around in Hells Kitchen two weeks ago, an area of Manhattan I have lived in for more than 10 years, I noticed a lot of closing businesses. This used to be a thriving area, one where even the financial elite were buying places. I sat down with a bartender whom I’ve know for awhile to give me the zeitgeist of what was happening.
He told me that “AirBnB is ruining this area.” The impersonal nature of visitors to the city was destroying their business model. The locals see each other regularly, who then treat each other fairly because they know they will have to deal with them tomorrow. The normal tips they expect evaporate when transients come and visit, undoubtedly with different cultural norms for this type of thing, but also because they don’t have to face them tomorrow.
I love AirBnB, but I love New York more — and it is not the same city if everyone who stays here is a tourist.
It’s hard not for me to draw the analogies between locals here in New York and locals in financial markets. Soulless, anonymous limit order books are the places where tourists can come and go, putting orders when it’s convenient and leaving when it’s even more so. The biggest achievements in this arena are measured in things like co-location facilities and microsecond latency improvements. Totally boring, in my view.
“Face to face” is different — individually negotiated agreements with people you will have to deal with tomorrow is always going to be unique.
Last month, I asked Judy to do me a favor. I wanted to have two of our people from LedgerX visit, in person, the Chicago pits that made trading so famous. These places were viewed for years as an anachronistic institution catering to locals, doomed to failure due to the unstoppable virtues of electronic, ephemeral trading. Yet these physical trading areas were still stubbornly surviving and more bizarrely, a company at the forefront of cryptocurrencies spent money to send people there.
Judy called Rex, the broker who had let her out of a bad trade more than a decade ago. He was happy to help. Despite him having done her the favor back in the day, he didn’t hesitate to do another one.
After the LedgerX folks landed back in NYC, I asked them for any impressions about Chicago trading. One story came up about a trader who said to them, while pointing to another local in the pit — “I know if I screw him today, he won’t trade with me tomorrow.”
There is something to this idea of being a local.
About the Author
Paul Chou is a regular contributor to LedgerX. This has been adapted from a forthcoming product announcement.