Absolute vs. relative speed in high-frequency trading

Abstract

This paper addresses the little investigated topic of the relationship between the speed of exchange servers, an absolute reference for the system, and trading speed, considered relative to the former. This is a major issue, as trading speed overwhelming the capability of the server to cope with the incoming orders might jeopardise the orderly functioning of the markets. It will be shown how, by raising the speed of trading and increasing the number of the agents operating in the market, it is possible to generate a crisis, no matter how performing the exchange server is. The paper presents a theoretical framework and then verifies its occurrence by analysing audit trail data. The theoretical framework shows a scenario in which under certain, heavy but by no means uncommon, conditions, the excess speed of the trading agents with respect to servers is capable of exacerbating price volatility, leading to vicious feedback loops capable of potentially creating a financial crisis. The empirical part analyses data taken from a particularly volatile day and compares them with much less volatile days. It results that, because of excessive speed, one of the most widely used techniques for minimising risk, order churning, can cause a major crisis.