It’s high summer here in North America, and for a lot of us, this one has been a scorcher. Media reports have been filled with coverage of heat wave after heat wave, with temperature records falling like dominoes.
But as they say, it’s not the heat, it’s the humidity, and that was painfully true in the first week of July as a slug of tropical air settled into the northeast United States. With dewpoints well into the 70s (25°C plus) and air temperatures pushing the century-mark (38°C), people suffered and systems from transportation to the electrical grid strained under the load. But as punishing as such soupy conditions are for people, there are other effects that are less well known but of critical importance to financial markets, where increased humidity can lead to billion-dollar losses for markets. Welcome to the weird world of high-frequency trading.
Time Is Money
To understand how humidity can impact something like the stock market, it pays to know a little about the mechanics of markets, and how stocks and other financial instruments are traded in the real world of the 21st century. Most people know the basics of trading stock: buy low, sell high, profit from the difference. The arrangement once was that individuals or institutions would buy a certain number of shares of a company’s stock, hold it for a while to wait for it to appreciate in value, then sell it to someone else.
While that “buy and hold” model certainly still happens, increasingly the action in the stock market has shifted from investors to speculators, and the time frame for holding the stock has dropped dramatically. Where stocks were once held for weeks or month, or perhaps even years for certain companies, increasingly sophisticated technologies have driven the hold time down to days, hours, and even seconds. The idea with these trades is still the same — buy low, sell high — but the amount the stock appreciates over short time periods is minimal, often amounting to fractions of a penny. But when it’s a fraction of a penny profit on each of a million shares, and thousands of transactions can be executed every second, the profits can really pile up.
Another critical aspect to high-frequency trading is that the traders are competing against each other to lock in their ownership of a particular stock that appears to be poised for a big purchase by another buyer. They lock in a purchase and hold onto it for the few seconds it takes for that big buy order to come in, then they dump the stock. With fast access to upcoming trades and exquisite timing, the stock will appreciate slightly during the high-frequency trader’s brief ownership and they’ll earn a small profit on each share sold.
As you can imagine, the technology needed to accomplish this is highly specialized, with custom algorithms running on server farms to gather the information needed and execute the trades. Generally such infrastructure is located close to the exchanges that act as the heart of the markets, which for the US stock market means the cluster of exchanges in New York known collectively as Wall Street. The closer the traders are to the action, the better their information will be, and the better they’ll be able to compete with other traders.
The problem is that the systems traders use need to be connected to each other, and like any other network always have to contend with latency. To minimize latency, high-frequency traders tend to locate as close of physically possible to the exchanges, as less distance to cover means less time to send and receive messages that have a speed limit determined by the laws of physics. That’s not a hard rule, of course; some traders need rapid access to transatlantic data too, and are apparently turning to HF band radio links to gain the edge over other traders.
For short-haul links around the financial centers in New York, though, dedicated network links are favored for low-latency connections. Rather than trusting their trades to the vagaries of the Internet and risk an unfavorable routing path or a cable severed by an errant backhoe, high-frequency trading firms often rely on microwave links to exchange information. The links are similar to the microwave backbone that once stitched the phone system together: point-to-point links via dedicated microwave dishes. For the Nasdaq exchange, microwave dishes link the company’s data center in Carteret, New Jersey to the New York Stock Exchange’s data center in Secaucus, New Jersey, about 16 miles to the northeast.
Sweating It Out
But what in the world does the weather have to do with all this? How can a hot, humid day possibly negatively impact the world of high-frequency trading? As it turns out, those microwave connections are the weak link in the system. During the early July heatwave, the links were experiencing slight delays in transmission times over that 16-mile path and throwing off the timing of the trading algorithms. The delay was minuscule — on the order of 10 microseconds — but in a business where millions are made and lost in seconds, that’s substantial.
The physics underlying this uniquely first-world problem are well known. We tend to think that radio waves travel at the speed of light, and while that’s true in a vacuum, propagation speed varies slightly in different media. Air makes microwaves slower; increased humidity makes them slower still. In addition, microwaves are absorbed and therefore attenuated by water vapor in the atmosphere.
So humidity deals a double whammy to the high-frequency traders’ links, both delaying the microwave signals and reducing their signal strength. Such effects are well-known, having been noticed for years on long distance telco microwave connections and the backhaul links that stitch together the cellular network. Delays and attenuation don’t really impact those services to any great degree, but even over a short path like the link between those two New Jersey data centers, the soupy air that settled into the region was enough to slow the links by a few microseconds, which is an eternity in the HFT business.
So, the next time you Northeasterners are sweltering away in your steam-bath conditions in the long, hot summer of 2018, spare a thought for those microwaves whizzing over your head with a little less zip than normal. Those signals carry a fair slice of market liquidity, and as uncomfortable as you may be in those sticky conditions, those extra microseconds are making some traders sweat for an entirely different reason.