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The Digital Skeptic: Fast Traders Hit Speed Limit

Stocks in this article: SGI CSCO

NEW YORK ( MainStreet) -- In these nutty digital days, it's no longer what you know, who you know or when you know it.

Now it's where you know it.

"Geography is a new type of natural resource," said Alex Wissner-Gross, who explained the concept to me earlier this year. Wissner-Gross is an institute fellow at the Harvard University Institute for Applied Computational Science. He -- along with C.E. Freer, a similarly super-smart postdoctoral fellow at the Computer Science and Artificial Intelligence Laboratory at MIT -- are deep into the study of where traders trade in today's uber-fast digital financial networks -- as in where geographically, on the earth.

"Your geographic location might be quite financially valuable," Wissner-Gross says.

Back in 2011, the two published an interesting-to-read paper on how information travels on modern, global, so-called low-latency trading networks. These are the digital networks that connect major trading hubs such as the Nasdaq or the New York Stock Exchange to, say, the Chicago Merc or the London Stock Exchange. Trades on these networks supposedly happen in ever-faster millionths, billionths or, I guess, zillionths of a second.

But the more the two studied the reality of fast trading, the more they realized something profound: No matter how fast traders wanted to trade, our world has an absolute, dead-solid trading speed limit in the speed of light. So sure, investor can spend zillions on fast computers, super-duper optical cables and complex algorithms to trade a share of IBM (IBM) at $196.91 in a bazillionth of second between the Nasdaq and London Stock Exchange. But the information that describes that $196.91 price can only move up to the speed limit of light between these trading centers.

The farther away trades are, the longer it takes for prices to travel from trading hub to trading hub. And the greater the chance for that price to drop out of sync with market reality.

"As that information is flying from New York to London," Wissner-Gross says, "market conditions can change dramatically."

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