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“When a stock gets overheated, some form of stock-specific circuit breaker is a very effective means for letting information repopulate in the marketplace,” Lime’s Wecker told me a few days after the flash crash. He advocates an initial short-term cooling-off period measured in seconds or minutes; if a stock suffers a subsequent steep decline in price, the next halt would be longer.

Like many of the people I have interviewed about high frequency trading over the past five months, Wecker is concerned that regulators could try to rein in the practice by putting limits on technology. After all, his business is built on speed. “The challenge with speed bumps is that you are slowing down innovation to accommodate the players who have no interest in investing in innovation,” says Wecker, 47, who spent 11 years at Goldman, Sachs & Co., including six in its famed quantitative trading group, before eventually moving to Lehman Brothers to build its electronic trading group. He left Lehman in April 2008, five months before the investment bank filed for bankruptcy, and was hired by Lime founder Mark Gorton that November.

Lime handles hundreds of millions of trade orders a day. This spring it introduced a product called LimeInside that enables customers to place an order with Nasdaq, NYSE Arca and BATS in less than ten microseconds, on average — including real-time pretrade risk checks. That’s blazingly fast, confirms Tradeworx CEO Narang. It takes his group about 20 microseconds to do a trade from the moment a stock quote enters its system, triggers a signal, determines an order and passes through risk controls. Besides Lime, the only firms that are faster than Tradeworx, Narang says, are Tradebot and Getco.

Trading in the single-digit microseconds would be impossible for firms like Lime, Tradebot and Getco if they didn’t house their algorithms near the computer matching engines that power exchanges, ECNs and other electronic marketplaces. Brokerages, proprietary trading firms, hedge funds and other asset managers can lease co-location space in exchange-owned facilities (such as the NYSE’s Mahwah data center) or those owned and operated by third-party providers like Equinix.

Co-location has been a hot-button issue for critics of high frequency trading. I wonder, however, how many have actually visited a co-location facility. In March I got the chance to do just that at Equinix’s 340,000-square-foot NY4 data center in Secaucus, New Jersey. My host was Brandon Travan, head of the information technology infrastructure, co-location and cloud-hosting services divisions for Gravitas Technology, one of the growing number of companies that provide turnkey technology solutions for high frequency traders — and one of the first tenants at NY4.

From the outside, the white, two-story, unmarked building, located 11 miles west of downtown Manhattan in an area known best for outlet shopping, looks like a suburban medical office or law firm. (I later learned that it had been an eyeglass factory.) The lobby is equally nondescript, if not a little odd — there’s not much more than a phone, a plain steel door and a biometric hand scanner. After dialing in a personal code matched against the geometry of his hand, Travan got us into an inner lobby, where three security guards sat behind bulletproof glass and Kevlar-reinforced walls. I gave them my driver’s license (which, I was told, I’d get back when I left), and after two more sets of hand scans and steel doors, we entered the co-location area.

I was glad that I had decided to wear a light coat over my suit that day, because Equinix keeps the facility at a cool 65 to 72 degrees Fahrenheit. The design itself is also very cool. Built on a concrete slab with 45-foot-high ceilings, the building is organized along a rectangular grid system, with rows and rows of servers housed in metal cages for as far as the eye can see. Yellow trays snake above the cages, carrying all types of cables. Orange “innerducts” transport fiber-optic connections within the cages. Giant air-conditioning units, located outside the co-location area in case of a water leak, pump air through large green ducts that come down over the cages, creating a giant convection loop that sends the heat from the servers and networking equipment up toward the ceiling and out through the roof.

The facility is kept dark, both to improve its energy efficiency and to protect the anonymity of Equinix’s tenants. Each cage has lights that come on automatically when someone enters, I learned when Travan typed in the code to unlock his cage. Gravitas has about 35 clients operating out of its space, including one large hedge fund firm that spent more than $1 million on computer hardware, software and setup costs. The majority of Gravitas’s clients, however, are small. The company provides all of its clients with direct high-speed connections to all the market data providers and trade execution networks, including other NY4 tenants, like Direct Edge and the International Securities Exchange.

“We make the electronic trading community of Equinix available to smaller players by taking advantage of economies of scale — helping them get in with the technology they need with almost no up-front capital,” Travan told me. “If you’ve got a coder and the next best algo for trading equities, currencies or other vehicles, instead of needing a quarter-million dollars to start up, you can simply install your code on our hosting platform or send us servers to plug in, and you’re ready to go.”

Not everybody, however, buys the democratization argument. James McCaughan, CEO of Principal Global Investors, says co-location gives high frequency traders an unfair advantage. “Co-location creates an informational asymmetry that is fundamentally acting against the interests of long-term investors,” McCaughan told me exactly one week after my visit to the Equinix data center. “I have no problem with people developing algorithms for high frequency trading as long as they’re doing it with the same information as everybody else.”

McCaughan, whose team manages $215 billion in mostly 401(k) and other retirement assets for Principal Financial Group, considers himself to be a pretty savvy investor. His equity-trading desk has six people at the company’s Des Moines, Iowa, headquarters; two each in London and Singapore; and one in Tokyo, as well as access to state-of-the-art trade-execution algorithms offered by all the leading brokerage firms and third-party vendors. Although there’s nothing stopping Principal from using co-location, McCaughan told me that for a long-term investor, it’s probably not worth the effort. “As a large, sophisticated investor, we can compete,” he said. “But it is a weaker market if you have to be that sophisticated to compete.”

HIGH FREQUENCY TRADING BURST into the public consciousness last summer when news broke that a former Goldman Sachs Group computer programmer had been arrested by Federal Bureau of Investigation agents at Newark Liberty International Airport for allegedly stealing software code. According to the FBI, the programmer, Sergey Aleynikov, transferred thousands of files related to Goldman’s proprietary trading program to his home computers with the intention of using them to help his new employer build a high frequency trading platform. It didn’t take long for that employer, Chicago-based Teza Technologies, to cut its ties with Aleynikov. But Teza’s co-founders soon landed in hot water themselves when just six days after Aleynikov’s arrest, hedge fund firm Citadel sued them for violating a noncompete agreement and trying to steal its trade secrets. Last fall Citadel finally got the injunction against Teza that it was seeking, but by the time the judgment was rendered, the nine-month noncompete period had nearly expired.

The Citadel-Teza lawsuit provides an illuminating window into the world of high frequency trading. The person at the center of the drama is Mikhail Malyshev, a brilliant Russian émigré with a Ph.D. in plasma physics who joined Citadel’s high frequency ­trading group in 2003. During Malyshev’s six years at Citadel, the firm spent hundreds of millions of dollars researching and developing high frequency trading models and building out the IT infrastructure and systems to implement them. Its market data system, for example, contains roughly 100 times the amount of information in the Library of Congress. Citadel uses this historical data to test its models, which attempt to forecast changes in the prices of securities by analyzing statistical pricing patterns, supply and demand imbalances and other factors. The signals, or alphas, that prove to have predictive power are then translated into computer algorithms, which are integrated into Citadel’s master source code and electronic trading program.

Malyshev oversaw all aspects of Citadel’s nearly 60-person high frequency business, including the approval of trading strategies. He resigned on February 16, 2009; the next day his top lieutenant, Jace Kohlmeier, left too. By April they had incorporated Teza. Last fall, while I was reporting my story on Citadel, Kenneth Griffin, the firm’s billionaire founder and CEO, told me that before the arrest of Aleynikov, he had no idea what Malyshev and Kohlmeier were doing at Teza. After all, he said, the two were still on Citadel’s payroll as part of their noncompete agreements.

Like most hedge fund firms, Citadel is secretive about its investment strategies. The fact that Griffin would pursue a very public lawsuit with Teza’s founders says a lot about the importance of high frequency trading to the $12 billion-in-assets Citadel. In 2008 its high frequency group made $1.15 billion, compared with gains of $892 million the previous year and $75 million in 2005, according to Malyshev’s testimony. The 2008 performance was especially impressive given how poorly Citadel’s large multistrategy funds did that year: Its flagship Kensington and Wellington funds were each down about 55 percent.

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