NYU-PolyFinance and Risk Engineering Department

NASDAQ Connectivity &Algorithmic Trading

Course: FRE 7251- Algorithmic Trading & High Frequency FinanceProfessor: Roy FreedmanSemester: Fall 2013Group # 4Members: ID Surya L Gurung0449604Cheng-Fang Lin0466478

12/16/2013

Abstract:Nasdaq changed the stock trading world by inventing first electronic trading market in 1971. In this paper, we are going to start with a brief history of Nasdaq. Our primary focus is going to do a case study on the NASDAQ connectivity.NASDAQ provides many different ways to its customers to connect to its major U.S. data centers directly. It also provides many different protocols to implements financials their own algorithmic strategies. So, we will discuss the different ways to connect to NASDAQ data centers and different protocols.

NASDAQ and Its History:NASDAQ was founded in 1971 by the National Association of Securities Dealers (NASD). So, it is basically a collection of connected hundreds of dealers who are allowed to make markets in a particular stock. (Freedman, 23) It is regulated by the Financial Industry Regulatory Authority (FINRA), the successor to the NASD.(3)NASDAQ began trading on February 8th 1971. It was the world's first electronic stock market. At first, it was merely a quotation system and did not give a way to actually do electronic trades. The NASDAQ helped lower the spread but it was unpopular among brokerages because it made them difficult to make money on the spread.(3)In the beginning, NASDAQ was the successor to the over-the-counter (OTC) system. Even around 1987, the NASDAQ exchange was still commonly referred to as the OTC in media and also in the monthly Stock Guides issued by Standard & Poor's Corporation. (3)After 1987 market crash, Small Order Execution System (SOES) was established, which provides an electronic method for dealers to enter their trades. NASDAQ requires market makers to honor trades over SOES. But this system allowed to give birth of entirely new era of electronic trading, Algorithmic Trading. Sheldon Maschler, Jeff Citron, and Josh Levine discovered arbitrage over SOES system by developing low level fast software. (1) The firm was called Datek Securities. It was the beginning of the High Frequency Trading.In 1992, it joined with the London Stock Exchange to form the first intercontinental linkage of securities markets. NASDAQ separated from NASD in 2000 to form a publicly traded company, the NASDAQ Stock Market, Inc. In 2006, NASDAQ changed from stock market to licensed national exchange. In 2007, NASDAQ bought the oldest stock exchange in America Philadelphia Stock Exchange (PHLX) and the Scandinavian exchange group called OMX to become The NASDAQ OMX Group.(3) The NASDAQ OMX Group owns and operates 24 markets, 3 clearing houses, and 5 central securities depositories. Eighteen of our 24 markets trade equities. The other six trade options, derivatives, fixed income, and commodities. (2)Following are the markets, clearing houses, and securities depositories:

Since its inception in 1971, NASDAQ OMX Group has become world biggest stock exchange. Lets see the growth of NASDAQ in following graph.

Source: nasdaqomx.com

NASDAQ Connectivity:Any firm who needs the lowest latency data feed, NASDAQ OMX offers direct access to its U.S. equity and derivatives data feed products from its U.S. data centers. They can connect to Nasdaq U.S. data centers via 1. Co-Location2. Wireless Connectivity3. Extranets4. Direct ConnectivityInvestors and Traders can also access to Nasdaq data feeds through more than 100 authorized market data redistributors. (7)

Co-Location:It is opportunity provided by an exchange to the high frequency firms to place their trading computers directly next to the exchanges computers in their data centers for some fee.NASDAQ offers networks in 10G, 10G Ultra, and 40G Ethernet for all Nasdaq OMX order entry protocols and data feeds. (8) Wireless Connectivity:Metro Millimeter Wave (MMW) network connects customers in Nasdaq data centers to traders in New York Metro trading hubs in 40% faster than any fiber based network.(10) NASDAQ OMX, in conjunction with CME Group, recently started providing a new wireless connectivity offering providing a direct, low-latency microwave route between Carteret, NJ, and Aurora, IL, for delivery of select NASDAQ and CME data up to 36% faster. (9)

Where is the Nasdaq Data Center?The main Nasdaq data center is located at Carteret, NJ. Following aerial view is the building housing the data center where actual trading happens.

Extranets & Direct Connects:Firms outside the Nasdaq OMX data centers can connect to Nasdaq OMX data centers through approved third party Extranets or Direct Connect networks providers. The monthly co-location fees for the Nasdaqs data center in Carteret, NJ (where all the trading actually happens) run up to $14,000 per month. (6) Not all traders can afford this price.

Equity Protocols: Financial Information eXchange (FIX) FIX Lite OUCH Routing and Special Handling (RASHport) Nasdaq Information exchange protocol (QIX) Computer-to-Computer Interface (CTCI)

FIXFIX is created by Fidelity and Salomon Brothers in 1992 to communicate electronically between buy and sell sides. (Freedman, 247) It is a vendor-neutral standard message protocol that defines an electronic message exchange for communicating securities transactions between two parties. It is free and open standard format used today by most of U.S. firms in the options securities business.(14) FIX supports message for order entry, cancel, and modify for1. US Equity trading2. Option trading3. Order routing system ACES4. Trading reports (14)

OUCH This protocol allows customers to quickly enter orders into and receive executions. OUCH subscribers and their software developers can integrate NASDAQ into their proprietary trading systems or build custom front-ends to NASDAQ systems.OUCH accepts limit orders from system subscribers, and if there is a matching order, they will execute. Non-matching orders are added to the Limit Order Book, a database of available limit orders, where they are matched in price-time priority. OUCH only provides a method for subscribers to send orders and receive status updates on those orders. (18)

RASHport RASHport allows subscribers to enter orders, cancel existing orders and receive executions while providing smart order routing and special handling features. RASHport also provides advanced functionality and the ability to process sophisticated order types including discretion, random reserve, pegging and routing. (15)CTCIIt is a method by which NASDAQ subscribers can enter transactions, such as NASDAQ Market Center orders and trade reports, from their computer systems to NASDAQ's computer systems without using a NASDAQ Workstation. CTCI interface is based on the Common Message Switch protocol. (16)QIXIt is an efficient protocol that allows automated, real-time trading. QIX offers reliability in placing orders and quotes in the NASDAQ system, while providing improved throughput and reduced latency. (17)

Algorithmic TradingIt is a computarized trading using proprietary algorithms. In this trading the speed of data feed (fastest boat in Jim Fisk Algorithm), reliability and data quality are essential. This is the reason why Nasdaq Connectivity is so important for the High Frequency Traders.As Professor Freedman mentioned, it is the Nasdaqs connectivity issues (late to update quote) which lead to creation of Datek and eventually birth of Algorithmic Trading.

Algo-Testing Facilities:NASDAQ provide next-generation Algo testing environment offering a market-wide equities testing platform that provides a comprehensive testing universe well beyond just the NASDAQ market systems. The Algo Test Facility will provide High Frequency traders with a safe environment to rigorously test and calibrate their algorithmic strategies by replaying and interacting with real historical market data. (19)

Conclusion:Nasdaq changed the stock trading world by inventing the first electronic trading system. Even though, Nasdaq has made the electronic trading market more robust and advanced by continued technological innovation, I think lots of challenges still remains unsolved. Periodic news of flash crashes because of various algorithmic glitches such as one in Aug 22nd, 2013 could cause investor to lose their confidence in electronic trading markets.

References:1. Freedman, Roy S. Introduction to Financial Technology. Academic Press/Elsevier, 2006. Print. 2. What is Nasdaq? Nasdaq OMX. Retrieved from http://www.nasdaqomx.com/aboutus/company-information/whatisnasdaq on 12/14/20133. Nasdaq. Wikipedia. Retrieved from http://en.wikipedia.org/wiki/NASDAQ on 12/14/2013 4. Traders. Nasdaq OMX. Retrieved from www://www.nasdaqtrader.com 5. Nasdaq OMX Timeline. Nasdaq OMX. Retrieved from http://www.nasdaqomx.com/aboutus/company-information/timeline on 12/15/136. Mid-Week HFT Primer: Co-Location. Retrieved from http://www.floatingpath.com/2013/07/03/mid-week-hft-primer-co-location/ on 12/14/13 7. Market Data Vendors. Retrieved from http://www.nasdaqtrader.com/Trader.aspx?id=MarketDataVendors 12/13/138. Low Latency Connectivity. Nasdaq OMX. Retrieved from http://www.nasdaqtrader.com/content/Productsservices/trading/CoLo/LowLatencyFS.pdf 12/14/139. Nasdaq OMX Co-Location. Nsdaq OMX. Retrieved from http://www.nasdaqtrader.com/Trader.aspx?id=colo on 12/14/1310. Wireless Connectivity: Metromillimeter Wave Offering. Nasdaq OMX. Retrieved from http://www.nasdaqtrader.com/content/Productsservices/trading/CoLo/millimeter.pdf on 12/14/13 11. Margaret Rouse. RASHport. Retrieved from http://searchfinancialsecurity.techtarget.com/definition/RASHport on 12/14/13 12. Margaret Rouse. QIX. Retrieved from http://searchfinancialsecurity.techtarget.com/definition/QIX on 12/14/13 13. Margaret Rouse. CTCI. Retrieved from http://searchfinancialsecurity.techtarget.com/definition/CTCI 14. FIX. Nasdaq OMX. http://www.nasdaqtrader.com/Trader.aspx?id=FIX on 12/14/13 15. RASHport. NasdaqOMX. Retrieved from https://www.nasdaqtrader.com/Trader.aspx?id=RASH on 12/14/1316. CTCI. Nasdaq OMX. Retrieved from https://www.nasdaqtrader.com/Trader.aspx?id=CTCI on 12/14/1317. QIX. Nasdaq OMX. Retrieved from https://www.nasdaqtrader.com/Trader.aspx?id=QIX on 12/14/1318. OUCH. Nasdaq OMX. Retrieved from https://www.nasdaqtrader.com/Trader.aspx?id=OUCH on 12/14/13 Nasdaq Testing Facilities. Nasdaq OMX. Retrieved from https://www.nasdaqtrader.com/Trader.aspx?id=TestingFacility on 12/14/1319. Chuck and Campos. Nasdaq market paralyzed by three hour shutdown . Retrieved form http://www.reuters.com/article/2013/08/22/us-nasdaq-halt-tapec-idUSBRE97L0V420130822 on 12/14/13

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