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Supercomputers Speed Up Game
Wall Street Journal
4/14/2006

Delete: the stereotype of a wise-cracking trader. Replace with: supercomputers so sophisticated that they are programmed to replicate the occasional human mistake.

Over the past several years, trading on global stock exchanges has exploded, and many of the world's biggest exchanges are considering mergers that could further reshape the industry.

Much of the jump in business is due to the rise in electronic trading.

Today, computers can spot and capitalize on tiny price discrepancies in milliseconds, such as a difference between a stock listed on two exchanges separated by an ocean. Banks, hedge funds and other big investors have direct feeds to exchanges that bypass brokers and let them trade much more easily and often.

The bottom line: Exchanges that offer the quickest access and the widest possible range of securities will attract the most business, hence the push to consolidate. "The end game is a global exchange that spans the three major regions: the U.S., Europe and Asia," says Mamoun Tazi, an analyst who follows exchanges at Man Securities in London.

Most recently, Nasdaq Stock Market Inc. took a 15% stake in London Stock Exchange PLC in what many view as a major step toward a full-blown bid. London, meanwhile, continues to hold discussions with other exchanges about possible combinations, including informal talks about a possible tie-up with NYSE Group Inc., operator of the New York Stock Exchange, according to people familiar with the matter.

Buyers and sellers have been matching up electronically since the 1980s. But an increase in computer capacity readily available to even small hedge funds -- investment pools for institutional investors and wealthy individuals -- has changed the game. "With four people and 50 computers that have the power roughly equivalent to a Cray supercomputer, we can achieve what someone else would need one trader and 100 analysts to accomplish," says Jonathan Kinlay, chief executive of Proteom Capital Management Ltd., a Bermuda-based hedge fund with about $100 million under management.

Proteom uses computers to execute complex trading strategies based mainly on stocks in the Standard & Poor's 500-stock index and their tendency to rise or fall sharply and quickly, a measure known as volatility.

"This business could not have existed 10 years ago [because] the computational power was not available," Mr. Kinlay adds. "The execution of a trade, the analysis of the live data, the updating of databases and the construction of portfolios of stocks are all automated."

Such trading helped motivate the NYSE to embrace a new "hybrid" system that will allow investors to send orders of any size to its computers instead of floor traders. "There is an arms race [among exchanges] to be the fastest," says Steve Swanson, president of brokerage firm Automated Trading Desk LLC, whose customers -- mainly retail brokerages -- demand "instant" trade execution.

Automated Trading Desk's average daily business in U.S. stock has increased to more than 200 million shares per day from 140 million shares at the beginning of 2005.

When the firm receives an order, humans don't touch it. Instead, computer programs send the buy-or-sell instructions in about 25 milliseconds to whichever exchange or electronic network has the best price.

Computer programs also decide in some cases whether the order should be sent immediately or held for a better price. But like most technological advances, the rise in the speed and power of trading raises tough questions about those who may be left behind -- in this case small investors.

Most individuals trading for themselves still need to see a price and then click a computer mouse to buy or sell. Such a trade could be seconds behind supercomputers constantly trolling the globe for bargains.

There is no question, however, about the benefits to exchanges that combine fast trading with heavily traded stocks.

At the London Stock Exchange, Europe's largest stock exchange, the upgraded electronic-trading system known as SETS saw a 69% increase in the value of shares traded in March from the year earlier. Trading volumes on SETS are expected to increase by 22% in 2007 over this year and another 18% in 2008, according to Credit Suisse.

In the Windy City, the Chicago Mercantile Exchange, the world's largest derivatives exchange, processes about 70% of all trades through its Globex electronic system. And at the Chicago Board Options Exchange, which also trades derivatives, options-trading volume grew about 30% last year, largely because of the ease traders have in using electronic systems. "Technology has helped the business grow," says William Brodsky, CBOE's chairman.

Technology also has helped the share prices of listed exchange operators themselves, making them among the highest-flying financial stocks of recent years.

Shares in the Chicago Merc have risen 14-fold since the exchange's initial public offering in 2002. Shares of NYSE Group, the company resulting from the merger of the Archipelago electronic exchange and the NYSE, have risen 17% from their March 8 debut.

Nasdaq's shares, little changed from 2002 to 2004, have soared over 300% since. London Stock Exchange's stock price has risen to over 12, or about $21, from about 3.50 at the end of 2004.

To encourage even more trading, LSE and others are offering big investors direct links to their trading platforms.

Direct access also has reduced trading costs. At Standard Life, for instance, the United Kingdom investment firm's ability to bypass brokers has reduced commission payments sharply, says Steven Way, head of European equity trading. It also helps Standard Life by keeping their strategies hidden from competitors.

Such anonymity -- another hallmark of computer dealings -- can be useful to a big investor looking to move a large block of stock.

Say a fund wants to move a stake equivalent to 10% of a company it holds in a portfolio. A computer can divvy up that block into 100,000 separate orders then drizzle them across the market, causing minimum disruption to the stock's price.

So is there any room left for the traditional stockbroker?

"There is still a place for a gutsy trader who makes sensible market calls," says Tim Wildenberg, head of Direct Execution Services in Europe at UBS. "Computers can't replace them. They can, however, help them unwind a position."

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