[00:03:32] The origins of High Frequency Trading

[00:09:23] Balancing Risk and Reward: How to Assess the Profits of Market Makers

[00:10:52] ‘Flash Boys’ by Michael Lewis

[00:15:37] Risk Management from a Market Maker’s Perspective

[00:28:41] Does Everybody Benefit from the Rise of Electronic Market Makers?

[00:31:26] The Global Expansion of High Frequency Trading

[00:36:09] The Future of Electronic Market Making

Pritesh: [00:00:00] Welcome to our third ever episode of Talking Edge. I’m your host, Pritesh Ruparel, Chief Executive Officer at ALT21. This morning, I’m honored to introduce our guest today, Robert Smith. Rob is a world class technologist who’s held many senior roles in the industry.

I know Rob is a humble man, so hopefully he won’t mind me running through his CV. Rob was formerly Chief Technology Officer and Head of Asia for GETCO, where he was responsible for spearheading their expansion across global markets. He is also former head of Europe for Knight Capital Group, and is currently the Founder and Chief Executive Officer of Applied Financial Technology Ltd, in London. Rob, welcome.

I know we have many of your friends and peers in industry joining us this morning, but for those of you who don’t know you Rob, maybe you could start off by giving us a little bit about your background, how you got into the space, what brought you here and what’s going on with your current venture, Applied Financial Technology?

Robert: Sure. I started life as a technologist. I went to the University of Massachusetts, got a degree in computer engineering. I came out into the industry, realized that software was interesting, but sitting in a cubicle and plugging away all day wasn’t what I had in mind. I ended up going back to school, getting a degree in finance.

It turns out that when I came into the industry, that was a pretty good combination. It brought together the way the world was moving, and just was a good timing, I think, for the way the industry was moving.

I was living in Boston, ended up working for a hedge fund there; moved to Chicago, ended up working a hedge fund there, and then joined GETCO back in 2001.

From there, a few years later, put together the business plan to open up Asia. Moved off to Singapore, was there for five years, built that side of the business. Then I was asked to come to the UK and take over the office that was here.

Not long after I arrived in the UK, we went through the merger with Knight Capital and the business changed dramatically. I thought about retiring, realized that I still had more to give. It set up. Applied Financial Technology is trying to leverage my background in being in the trading industry for many years, but recognizing how things had changed and wanting to do something a bit different.

Financial markets are huge, and there’s all kinds of different ways that you can participate. There’s all kinds of different strategies and technologies that you can apply. It’s really a very engaging and challenging way to try to ply your trade around technology and trading, but in different ways.

We have a bit of a different model here, but it’s really trying to leverage technology in ways that haven’t been leveraged in the past.

The origins of High Frequency Trading

Pritesh: [00:03:22] That’s very interesting. Maybe a good starting point would be to get you to explain to the audience, what is high-frequency trading?

Robert: What we used to say, high frequency trading; high frequency is a time frame, not a strategy. I think there was a big misnomer. I think the term was coined by a journalist. When we came into the industry, there wasn’t a thing like high-frequency trading. There weren’t firms that were high-frequency trading firms.

I’ll go right into what I see is the origin of this. If you go back 2,500 years, you had Greek merchants who’d go to the hillside, standing and looking at the ships coming in from the ocean and seeing how heavily laden they are with their goods: oil, olive oil, whatever. What do you do with it? I don’t know. You run down in the market. If there’s a lot of supply coming in, maybe you lower your prices. If ships are very light, maybe market prices up.

Fast forward 2,400 years, you’ve got Baron von Reiter in 1847, who’s using carrier pigeons to get financial news between Berlin and Paris. 16 years later he’s got some deal with ships coming in from the US, they throw canisters of new into the water off the Southwest corner of Ireland. He’s telegraphing that to London, again, to get news there faster.

The point is that over time technology has changed, but people have always understood the value of, of getting information faster and faster. High-frequency trading as you see it today is not a new thing that all of a sudden somebody discovered something, or some technology just appeared on the scene. It’s been an evolution over hundreds and hundreds of years because people understood the value of getting information and using that information in financial markets.

Technology has just continued to progress over that time. Everyone’s familiar with Moore’s law, that every 18 months you have a doubling of the compute power. The same thing has happened, not just in computing power, but telecommunications and the capacity of systems to generate information and transmit information. It’s really just been a historical evolution.

More recently though, in 1993, two academics wrote a paper which was looking at spreads in NASDAQ. They were Christie and Charles, I think were their names. This paper was questioning, why are all NASDAQ quotes a quarter wide? 25 cents wide. That led to a major lawsuit by the SCC against these dealers, and hundreds of millions of dollars in fines. The NASDAQ dealers were colluding, or that was the premise of the SCC.

That led to some changes in regulation. The SCC updated their order handling rules, which provided more transparency around prices and brought more liquidity on the screen, if you will. SCC then also passed Reg. ATS a little while later, which enabled new types of exchanges – ECNs, electronic communication networks. I don’t know where they got that name, it seems like a little strange. But you had these regulatory changes coming down the line.

A few years later, like 2000, 2001, you have decimalization coming into the industry. Instead of stocks, trading in quarters and eights and sixteens, now you have penny pricing. You had a really big shift in who’s participating in the industry, and how they’re participating. You really need to use technology at this point, because it’s no longer a quarters and eights, your spreads go from being 25 cents wide down to one penny. That I think had a really big disruption in the industry. Things were just always changing.

I think that highlights another point, which is important. Regulators have a really tough job, because what they need to do is to be looking at their constituency. On one hand, they need to protect investors. That’s one of the major functions, they need to protect the public. But at the same time, they also need to enable competition. Reg. ATS, for example, is the kind of regulation that enables competition in the market, and that enables innovation, that enables changes. Those changes in the end, end up helping investors because you create more liquidity, you narrow spreads.

Anyone who’s participating in these markets now, their total cost dramatically decreases. it’s a fairly important function of the regulators to provide protection, but also enable competition because in the end that helps investors as well.

Pritesh: Was the point where things moved to decimalization, the point at which you realized this was going to be a structural market shift, or was it later on?

Robert: I would love to say that I sat there and recognized what’s happening. I was in the middle of it. I joined just after decimalization was a thing. I remember when I was growing up, looking at the Wall Street Journal and looking at the prices of stocks, “Okay, this is a 47 and a quarter.” But when I joined GETCO, prices were in decimals and it’s on the screen. I didn’t really come into and was able to sit there. Now, I see the way the world is going. In hindsight, it all seems to make perfect sense, but at that time I had no idea.

Balancing Risk and Reward: How to Assess the Profits of Market Makers

Pritesh: [00:09:23] Fair enough. One of the big debates, as you say, that the market has is this balance between risk and reward. Different people have different opinions on whether the profits that market makers make are fair or not, or whether the fruits that they’re enjoying are the result of regulation and technology arbitrage. What’s your view on that?

Robert: I think that if you look at the large market makers, they invest huge amounts of money in technology. They are putting their own capital on the line. I think to say that it’s just regulatory arbitrage – market making is an incredibly competitive space. I don’t think you could start a market-making firm today without a couple of hundred million in capital, because you need the data centers, you need the lines, you need the hardware.

People look at, well, how much profit are they making? But what they’re missing is the enormous investments that these firms are making. I don’t think it’s unfair at all. Any business, any corporation, the whole point is that you take resources like capital and technology and people, and do something productive with that. I don’t think that the level of profit is at all outsized for the amount of investment that goes into that kind of business.

‘Flash Boys’ by Michael Lewis

Pritesh: [00:10:52] I’m assuming from that, many of this audience will have read Flash Boys and seen Michael Lewis’ positioning with the industry and almost villainization of it. How do you feel about this?

Robert: I think it’s a little bit unfortunate. I will start by saying, I love Michael Lewis. I’ve read all his books and I really enjoy all of them, I feel like I’ve learned a lot. This particular one though, was because I was so embedded in the industry. I did feel like, there’s a scene in the book where Brad Katsuyama is in his boss’s office, and they discover that by placing a trade they light up the screens and there’s activity in all these other data centers.

Yeah, that’s way that the market works. Partly it is through regulation, Reg. NMS. Reg. ATS brought all these other trading platforms, Online Ireland, ARCA group. Then you have Reg. NMS where now all these data centers, all of these market centers, are connected. I think at one point somebody had quoted something about those 250 different venues that you can trade or share a Microsoft on in the US. That’s a result of competition, that’s a result of innovation. But what’s wrong with that? I don’t think there’s anything wrong with it.

There’s definitely a balance between fragmenting liquidity, but at the same time, do you want to stifle innovation, so it all is one place and one exchange has a monopoly? I don’t think that’s the right answer either.

You can’t look at the industry and say, this is wrong, or this is evil. In fact, if you think about Flash Boys, what’s the origin of the name? I don’t know if this is exactly what Michael Lewis was thinking when he titled the book, but I believe it was Brute as a platform, had an order type called the flash folder. What they would do was you had market participants connecting to the exchange, connecting to their platform. Because other platforms would charge routing fees for their orders, Brute’s idea was if an order was not filled to show it to people who are directly connected to them in order to save money for the people who are trading, by not having their outbound of the order. They’re putting this forward as a benefit, and it’s a benefit. You’re trying to save someone money, that’s an innovation. But then all of a sudden, it ends up with this really evil connotation. ‘Oh, these guys are seeing the orders first!’ Well, yeah, but why? Because they’re trying to save people money.

The motivation behind the whole thing is about bringing more innovation and more competition to the market. If someone says, “I’ve got a way to save you money,” what are you going to say? “No, I don’t want to do that. That’s crazy!”

If you really understand the origin of some of these things, it’s not evil. It’s not trying to take advantage of people. Different businesses are out there trying to more price competition and more efficiency throughout the whole system.

Pritesh: Yeah. You feel it is possible to draw a clear distinction between predatory trading and genuine market-making.

Robert: I struggle a little bit with the term ‘predatory trading’. What is predatory trading? No one forces someone to put an order on the market. If you don’t want to buy or sell at a certain price, you shouldn’t put the order there in the first place.

All of these electronic platforms, you’re putting an order out there. Yes, if there’s 250 different venues you can try to share a Microsoft on, then not every single price is going to be identical. I would say that through time, the liquidity in these markets has increased dramatically. That’s going to bring the price as much more in line. If there is some oddball pricing out there, yes, it can happen, but is it going to happen all the time? Are you going to build a business on that? No, you’re, you’re not going to.

It may happen, but again, the term ‘predatory pricing’, who are you praying? That doesn’t even make sense to me.

Risk Management from a Market Maker’s Perspective

Pritesh: [00:15:37] Fair enough. One thing I’d love to talk to you about is understanding from a market maker’s perspective some big events. if we take, say the flash crash in 2010, many of us who were trading – I wasn’t an electronic market maker, but I was a market maker in the derivatives market, and I just remember watching CNBC and seeing DOW getting slammed a thousand points. You’ve got Jim Cramer talking about Proctor and Gamble and how it’s a buy, and the stock moves up 25% in minutes.

In your mind, what triggered that move, and what was it like trading that day from a market maker’s perspective?

Robert: I think what triggered it, what I had heard was that there was a trader who essentially fat-fingered an SMP order into the CME, and because of the interconnectedness of markets you have your same basic risk, which is your S&P 500 risks. But you’ve got the futures, you’ve got options, you’ve got ETS. You have the underlying stocks. There was so much selling pressure from this algo that it was trying to redistribute itself throughout the market.

When you have huge amounts of excess order flow coming in, there are technology systems behind this that sometimes cannot handle the capacity. Reg. NMS that was passed in the US mandated the interconnectedness of the markets and the quotes. I think the market was just flooded.

From a market making perspective, any market maker, especially ones who have obligations, are willing to be buying all the way down and selling all the way up. it’s not pretty, but you don’t sit there and say, “Well I think I’ll turn off now.” Market makers, their function is to provide a two-sided quote to provide liquidity in the market. They’re taking all the risk on that.

As a market maker, what you’re hoping for is that the market comes down a bit and recreates an equilibrium point where you have enough two-way flow that you can maybe make back the losses on that. But market makers are standing there, and again, buying all the way down. They have massive risk. Again, if they ended up making a profit, well, they took a massive risk. They put their own capital on the line. It’s not an unfair situation. They’ve signed up for those obligations and a lot of times market makers have some benefits. You get rebates, you get lower trading. But you will have to work for that. The exchanges are not just giving that away for free.

It’s a symbiotic relationship where they’re going to take the risk, but that’s their business. That’s what they’re doing. It was frightening.

Pritesh: Yeah, exactly. The motivation has to be there in one way, from a market maker’s perspective. When I look at it, these kinds of large one way sustain moves, you’ve seen some earlier this year with stocks, but you would just assume that for a market maker these are just lost generating events. Is that what it is? Do they take those losses with the overall flow of the business from which they profit from? Or are they able to turn these events into a profitable trading opportunity?

Robert: Again, it comes down to, on any sustainable in a short term, a market maker is going to take a loss. They’re going to sell all the way up. But what you’re hoping for is enough two-way flow on the liquidity there to be able to turn that off.

Depending on what products you’re trading, you’re trying to keep your Delta risk as low as you can. You’re selling at higher prices, but you’re trying to buy back as quickly as you can too. Generally, you’re going to have some days that don’t work out well, but you’re obligated to stay in the game and normally that would work out for you.

Pritesh: Yeah, that makes sense. The success of your critical mass in industry helps you in those positions. You’ve talked through the arguments for and against fragmentation of the market versus trying to concentrate into a single venue, but would you just give a quick summary on what you think the arguments for the fragmented structure are?

Robert: [00:20:14] If you look at the different platforms and you look at different pricing schemes that they’ve come up with over time, you see a lot of changes. You see a lot of innovation in the pricing structures through the exchanges. There’s a huge argument to be made, that enabling the fragmentation enables a lot of innovation in pricing and then in technology in what they’re offering. That’s a really important function of the financial market. Of any market, you want innovation because that’s what creates efficiency and lowers your cost.

At the same time, one of the primary functions of a marketplace, is price discovery. The more fragmentation you have, the more difficult price discovery becomes. That’s your argument against it. But at the same time, this was one of the basis of Reg. NMS, is you want to create more transparency across the different venues so you can get to a single price for an instrument.

Pritesh: One of the things I want to talk to you about is payment for order flow. Somebody has asked a question already about the main stock trends. I thought I’d put it into one. Payment for order flow has formed this commission-free trading industry that retail investors seem to be very heavily involved with. But do you think this is a favorable innovation, having that all in-costs in one commission-free structure? Or do you think there are other ways to manage it?

Robert: In general, I think it’s a fairly good structure in that you have this benefit to the entire investing public. I think the US across the globe has the highest number of households who are owners of stock compared to other countries. There’s a lot of retail trading out there, and it used to be. When I started, the first time I placed a trade, it was like 49.95. It was a discount. The US used to regulate how much commission there was? Then Charles Swab came on the scenes, and it was only 49.95 for stock trading. Whether you were going to buy one share or a hundred shares or five thousand shares, that’s incredibly expensive.

Now you have a zero-commission trading. I’m a big believer in people investing, long-term investing. Why not? If you’re a building to be a long-term investor, you may not get the smallest slice of a 10th of a penny on a share of stock, but at the same time now you don’t have to pay 10 bucks. A year ago it was like 9.95, then prices kept coming down.

I think it’s naive to think that firms that are providing services are not going to get paid. Really it’s about shuffling around how people get paid. I think that when you look at the fact that for a particular transaction, you’re giving up a very small price point; but if you’re a long-term investor that shouldn’t matter to you anyway. The cash out of your bank in order to pay the commissions, that’s a big change.

Pritesh: You say it’s led to a healthy, free market.

Robert: Yep. I think so. Just to be clear, it’s not just payment for order flow that has driven the commissions down. Different firms are now creating their own ETFs, they have more assets under management, they’re earning fees on these assets. There’s a lot of different streams of revenue. But what the brokerage firms are doing is turning around and lowering the cost and preventing competition amongst the brokers. I think that’s always a good thing.

Pritesh: [00:25:03] There’s one area, I guess, that people hear the phrase ‘dark pools’ and they suddenly go, what is this? But in my mind, the big development came around 2007 when some of the legislation was introduced that allowed investors to bypass the public exchanges to achieve better pricing. Do you think it’s a fair critique of dark pools to say that they create an uneven playing field among participants, whereby public participants have their bids, offers and prices visible to everyone yet selected institutionals and entities can execute out of the public eye?

Robert: I want to go back to, I think it was around 2003. GETCO was trading on the Island ECN, Island was getting to a point where there was an SCC regulation about lit markets, that one of these DCMS could not be more than a certain market share percentage. But Island had innovated, they had a liquidity adding rebate or their pricing structure was very innovative at the time. They were growing market share.

They got to the point that they could not publish quotes, because they were not allowed to by the SCC, because they weren’t an exchange. They were an ECN, there’s significant regulatory differences. I remember we were very nervous. All our systems are consuming these quotes and we’re generating our orders based on these quotes, what’s going to happen? They went dark.

In retrospect, it’s an unfortunate choice of terminology. ‘Dark’ implies evil or something underhanded. No, it’s just that they weren’t allowed to be lit. ‘Dark’ just made sense. But I think that if you had to go back, you might come up with something slightly different, like non-displayed quotes or something like that.

I think that it starts off on the wrong foot because just because of the terminology.

But again, what’s the SCC trying to do? They’re trying to protect the public. But then when you move forward, what the industry platforms are trying to do is to create better pricing. If you’re sitting around a trading desk long enough, you hear, who’s on the other side? Is Goldman on the other side of that? There’s well understood laws, that if you see Goldman you want to change your prices, you want to back away from that. But that doesn’t really serve the market as a whole particularly well, in that if you have a price for something, you have a large order you’re trying to put through, then why would you not want to get the price and not have a worse price, just because of your name, just because of your size?

I think that that’s another innovation. What the platforms are trying to do is just create more price competition, and better price discovery. All of a sudden it becomes, it’s not about the asset itself but about who’s trading it. I struggled to see that that is a bad thing. 

Does Everybody Benefit from the Rise of Electronic Market Makers?

Pritesh: [00:28:41] In terms of maybe other practices such as bringing computers closest to the exchanges, or laying fiber optic cables to give you an edge – is that some participants taking advantage of others, or is it truly just about market makers becoming more efficient?

Robert: I was at a party. My friends were hosting a birthday party for their one-year-old daughter. I was speaking to a doctor from NHS and we were just discussing what we each do. She asked, “What about those people who hack the exchanges to get the quotes faster?”

Oh my goodness! First of all, exchanges are highly regulated. Exchanges are not trying to cheat anybody. It doesn’t serve anyone any purpose. If your business model or your investing footprint is to buy a hundred shares of IBM a year, and build that over 10 years, you can absolutely build a co-location center, put lots of computers in there and get fiber optic cable and 10 gigabytes networks. But why would you want to do that? It doesn’t make any sense.

But it’s not that you have to be in some certain special club to do that. The exchanges are offering co-location centers, offering proximity hosting. They’re offering a whole menu of how would you like to connect? Do you want to go over the internet? Fine. You want a lease line. Fine. You want to be in the same building. Fine. They’re offering that because they recognize, in the same way that we talked about the history of the value of information, depending on your business model, that information has more or less value. You should appropriately size your technology investment to what your business model is.

There is no there’s nothing nefarious going on. People are sending out quotes before the trades happen, no. No, the laws of physics still do apply. That’s not happening.

I think that one of the unfortunate outcomes of the book is that people have this impression that the exchanges are cheating and there’s this club; and there’s not. Different companies, market makers, have put in substantial investment, and that’s their business model. No, it’s an unfortunate misperception, but it really doesn’t work that way when you look under the covers..

The Global Expansion of High Frequency Trading

Pritesh: [00:31:26] That’s good to understand. I think it’s the realization from Flash Boys comes back to all of this.

Your career is taking you to different parts of the world. In terms of the global expansion of HFD, everyone still feels they are maybe centric towards the West. But was there anything that surprised you in the way that the market-making activities expanded across new regions, such as Singapore and Hong Kong, and so forth?

Robert: If you look at a map of the globe, and you have the US, then Europe, then Asia, you can somewhat draw a line about where costs are lower, where liquidity is higher. When we used to evaluate a market, we looked at four different aspects of it. One was about liquidity, one was about cost, one was about technology, and one’s about regulation.

If think about the US market being the global benchmark, a lot of that is because there’s more liquidity, because there’s lower costs, because the regulators have enabled this level of competition. You have liquidity flowing to where competition is strongest, and where the regulatory framework works and enables price competition.

Over time you’ve seen others, VATs for example. It started off in the US and now it IS a very big player in Europe. But bringing that same competition and that innovation space to different markets.

Asia was particularly expensive. We had many conversations with the Singapore exchange about changing the pricing model. In the US, you never really dealt with basis point pricing, but in the UK, you did. In UK shares, you have stamp tax. You don’t have that, so now people would trade CFDs instead because they don’t have a stamp tax.

But as you look at the different regions, you have to compare those different things and you see the costs. Is there any wonder that liquidity is not as high as it is in the US? these things all play together.

Pritesh: That makes sense. Reading your bio, there was something interesting. In 2013, I think, KCG closed its Hong Kong office dues to a slow adoption of high-frequency trading. Even at the time, from what I understood, you were head of Europe, you basically pioneered GETCO’s expansion into Asia. What do you think were the factors behind this slower adoption in Asia, relative to North American markets?

Robert: Again, it comes down to the costs and liquidity. We had an office in Singapore, and that was the main office that we had. Then we had an open office in Hong Kong and one in India, and were connected to most of the markets of Japan, Hong Kong, Singapore, Australia. Each market required its own specialization, different brokers, different technology – really lots and lots and lots of differences that we had to adapt our trading platform to each of these markets.

We had the real luxury of having the core of the platform working extremely well, and the trading logic and the trading engines and the traders who really understood how to work with these markets. Our big task was to connect the different marketplaces to the platform. But again, each of the markets was smaller, and each of the markets was more expensive and took a lot more care, building the relationships, building the technology, building the data centers, to interact with each of those different marketplaces.

I think at a certain point, over that time with the merger between GETCO and KCG, there was a change of focus. Knight capital was not very big in Asia. I think there was a slight change in focus. Sensibly the company’s looking at, okay, how do we focus on the core business a bit more?

The Future of Electronic Market Making

Pritesh: [00:36:09] In terms of the future of electronic market-making, how has the competition from other high frequency traders and other liquidity supplying low latency traders impacted the market making landscape?

Robert: It’s always been a technology race. I think if you were setting out to start a high-frequency or a market-making from these days, you need a significant investment in technology.

One of the things that I believe is true about market making is that the core of the trading strategy is relatively straightforward. Basically, you want to be at the top of the book, as much as you can. It’s just that simple, except that that’s horribly complex from a technology perspective. You can’t be at the top of the book and be second, so it’s a race.

If you look at the kinds of infrastructure that were being put in place over time, I remember this is 2001, we had 128 9K line to Ireland. We were thinking about a fractional T1 where we actually went all the way in 1.544 megabits. A few years later, I call up one of our vendors and say, “I’d like to get a T3.” “A T3, are you kidding? I 45 megabits?” “Yeah, we definitely want that.” “Okay, fine.”

But then you’ve got 10 gig networks, you’ve got microwaves, now you’ve got lasers. As the technology progresses, these firms need to continue to invest. It’s always going to be who’s out there first. Who’s spending the money, making the investments in the technology, because of the value of getting the information first is incredibly effective.

Pritesh: How have the firms that founded this space been key in investing in faster connections and market data fees? Has that resulted in barriers for new people from entering the industry?

Robert: I’d go back to the fact that the financial markets are huge. They’re just enormous. Market making is one small slice of that market, but there are there are countless people out there with different ideas, different strategies, different ways to approaching the market. I believe that, yes, the leading edge technology (microwaves and lasers) are very expensive, but to get something just a little bit slower these days, you can have very high quality, fast connections for a fraction of what you could have had before.

The challenge is, what are you going to do with that? What strategy you want to employ? How are you going to monetize that? How are you going to set up your business?

But it’s such a vast landscape that to say that I can’t compete in the financial markets because these guys have lasers. That’s an incredibly defeatist attitude. I just don’t see that as making any sense. But again, as technology has progressed, what’s accessible to people? Now you have the CME putting all of their historical market data in the cloud. Do you want to tick by tick? It’s all out there. Market by order? It’s all out. It’s all out there for a fraction of the cost that it used to be.

To work with that data, you now spin up a data center with a shell script. You couldn’t do that in the past. I think that plenty of opportunity, and it’s unlimited. It’s limited only by the imagination of the people who are participating.

Pritesh: [00:40:06] There you go, for anyone who’s listening and dreaming. I think Rob has given you the green flag to go ahead. You just need to go for it, really. Ideation breaks new ideas at the end of the day.

Robert: There’s one point I wanted to go back to, about the risk of the business, and talking about technology and these data communication lines and things like that. One really important aspect of market-making or any automated trading, any algorithmic trading, is that if you have a decision engine in code, in a computer, the algorithm that you’re running is making a decision based on the information that is presented. Now, the higher your latency between the real market center where things are happening, and your decision engine, the higher your risk. Your algorithm is making a decision, but it’s assuming that it has the state of the world as the world exists at that time. But it never really does.

Go back to 1847 where something happened in Berlin and then there’s a carrier pigeon. The reason they were using pigeon is because it was faster than the train. But the world has moved on. A couple of days later the news gets somewhere, someone’s making a decision. The world has moved on; the world has changed. That is just as true on a day by day, hour by hour basis, as it is on a microsecond by microsecond basis.

The world has moved on. Prices have changed. You have the risk of making wrong decisions based on old information. Very sensibly, what you need to do is to get that information and process that information as fast as you possibly can. The landscape ends up looking like, if you can make better decisions, if you can make lower risk decisions, you can narrow spreads. You can lower the costs for the entire marketplace.

If you’re forced to be slow, then you have to recognize that risk. How do you compensate for that? You compensate for that by having a wider spread. But that doesn’t serve the investing public.

Pritesh: That makes sense. That maybe is a good way to lead to, I had a question come in from somebody, who says to level the playing field and address led conflicts of interest, should we regulate high frequency trading further? I guess that comes to the point of, is it going to slow things down?

Robert: I think the whole question about slowing things down, again, with Flash Boys, the investor’s exchange took 20 miles of fiber optic cable and put it into a box. It’s an interesting thought, but at the end of the day, what are you doing? Number one, you’re just changing the point to where the race is. Now the race is not to the matching engine of the exchange, it’s just to the entry point of the exchange.

You haven’t really accomplished all that much by doing that. It sounds good, but is it effective? Also go back to the fact that if the world has moved on and you have an exchange that is slower, you’re going to compensate for that by widening your spreads. It’s the only sensible thing you can do to compensate for the risk that you’re taking.

Does that really serve people? It’s hard for me to feel that Slowing things down makes sense because latency equals risk. It’s just that simple.

Pritesh: Brilliant. Well, Rob, this has been fascinating for me to have a chance to go through this with you. I appreciate you taking the time to join us.

Robert: You’re very welcome. Thank you.

Pritesh: I think it’s a good point to end it there. Thanks, guys, for attending. It’s been a pleasure. Thank you.