Speed Trading May Be Heading Out to Sea, Literally

Hedge funds and other players in the lightning-speed trading phenomenon could soon be relocating to far-flung regions, or even in the middle of the world's oceans, to defy the laws of physics and ensure maximum returns.

In 2010, research by Alexander Wissner-Gross, founder and chief scientist of software company Enernetics and a research affiliate at Massachusetts Institute of Technology, and Cameron Freer, a researcher at the University of Hawaii, looked at the way information travels between exchanges.

Traders work on the floor of the New York Stock Exchange.
Traders work on the floor of the New York Stock Exchange.

The two researchers then plotted the optimal points between geographically separated exchanges.

They discovered that trading from the optimal point would reduce the time it takes for information to travel between the two exchanges, enabling traders to buy low and sell high ahead of those confined to traditional financial hubs such as London, Frankfurt, New York and Tokyo.

With multiple players engaging in high-speed trading - buying and selling stocks at literally 90 percent the speed of light - even the tiniest fractional time advantage is a significant edge.

The research was designed to "explore the physical boundaries of liquidity" by devising a new way to buy and sell stocks, in turnaround times that were considered impossible due to light-propagation delays, Wissner-Gross told CNBC.com in a telephone interview.

"It provides a new source of liquidity - or what can be viewed as a new source of liquidity - because it allows for faster turnaround times for coordinated trading of geographically separated securities," he said.

"Many recent exchanges now have high-speed trading and prices are allowed to change on such short time scales, that the time it takes light to propagate between exchanges, for example between New York and London, is now a limiting factor in trading," Wissner-Gross added.

Optimal Trading Points

However, Freer believes there is scope to reduce transaction times at individual data centers, sparking a move towards optimal point trading in future.

"Transaction times within a given data center still have plenty of room to decrease," Freer told CNBC.com.

And as transaction times continue to fall, it will become even more relevant where they are conducted, he explained.

"As long as news and other tradable information continue to emanate all over the planet, there will be incentives to trade at intermediate locations, even if the major exchanges consolidate further," Freer said.

Wissner-Gross and Freer took the 52 largest stock exchanges as of 2008 and - based purely on geography, not infrastructure - they identified the optimal intermediate trading points between them.

In many cases, the best places to maximize chances of buying low in one place and selling high in another (for example between New York and London) were located in the world's oceans.

So could this be the end of traditional fixed stock exchanges in the world's biggest cities and the rise of floating exchanges in the mid-Atlantic ocean? Wissner-Gross believes that floating trade centers could be a reality of the future.

"In the long term there is the possibility that new infrastructure deployed in new places, including on the ocean, would be advantageous," he said.

There has been a flurry of interest from hedge funds and technology firms looking to take advantage of their findings, but Wissner-Gross did not reveal who exactly had expressed an interest.

"We've had a lot of interest from many players at multiple levels of the financial technology stack, ranging from actual ocean scale network providers to latency management software companies, to actual hedge funds themselves," he told CNBC.com.

"That's about all I can say at the moment, it's a very secretive industry."

Until floating centers become a reality, traders could still increase their profits by setting up offices on land, close to optimal locations, Freer said, pointing out that in the case of New York and London, Nova Scotia is the best approximation to the optimal point.

"Many areas with major exchanges, such as the northeastern US, Europe, and East Asia are also near many optimal intermediate locations, for which there are opportunities to optimize transactions using existing data infrastructure," he added.