Co-Location Archives

Every second counts when it comes to the cutting-edge world of algo trading (or even trading in general). Traders can earn significant profits in a matter of seconds by executing high-speed transactions. In this journey, many ‘big players’ use co-location servers to execute trades faster and gain an edge over competitors. In this article, we’ll explore the role of co-location servers and their importance in algo trading!

Why is ‘Speed’ a Significant Factor in Algo Trading?

Algo trading relies on the ability to analyse market data quickly. The market is constantly changing, with prices fluctuating rapidly. Algorithms can scan large amounts of data to find the perfect moment to make trades. In such fast-moving markets, getting data too late can mean missing out on opportunities or taking extra risks. The quicker an algorithm receives real-time data, the more accurately it can execute profitable trades!

Fast algorithms can place and execute orders more efficiently, reducing the risk of slippage (the difference between the intended price and the actual price at which the trade is executed). Moreover, when markets are volatile, algorithms can quickly react to changing conditions and adjust positions to minimise risk. Speed is crucial for implementing risk management strategies effectively. That’s why fast, reliable data is essential for success in algo trading!

What is a Co-Location Server?

Imagine the stock market as a massive building with walls that block signals. Far away traders, experience delays as the signals take time to reach them. Co-location servers function like powerful Wi-Fi routers, ensuring ultra-fast, lag-free connections for traders by bringing them closer to the data source. Co-location servers allow traders to place their machines close to the infrastructures of an exchange, enabling orders to be executed at faster rates. This gives them an advantage over those who are further away, thereby communicating changes in the market within a short time.

Before 2009, brokers and proprietary traders used certain machines linked with exchange servers. However, orders wouldn’t be placed during peak trading volumes or for certain connectivity problems. On various occasions, these delays meant huge losses in high-frequency trading (HFT), as every millisecond is crucial. As a result, firms lost out because of the slow pace of placing orders.

[Proprietary traders are firms or individuals that trade financial instruments using their capital, rather than on behalf of clients.]

To combat this problem, the National Stock Exchange (NSE) offered co-location services in 2009. Under this service, brokers can place their servers within the exchange premises. The service helped traders to get real-time tick-by-tick price data. This gave an advantage in the HFT game, where algorithms would execute trades under a second. Co-location allowed traders to respond instantaneously with minimal latency to stay ahead of the competition.

The Bombay Stock Exchange (BSE) started co-location services in 2011. Brokers place their servers inside the BSE data centre through co-location. For traders, this reduced latency, increasing the order execution speed. Being close to the exchange helped them obtain quicker access to real-time data!

Why Are Co-Location Servers Important in Algo Trading?

Now that you understand what co-location servers are, let’s look at some important aspects of it:

1. Low Latency:
These servers eliminate the need for data to travel across the globe, your trading system is positioned next to the exchange to collect data efficiently. Traders and firms get their orders executed faster giving them an edge over those who are waiting over long data travel times.

2. Better Data Access:
Co-location servers placed closer to an exchange have better access to real-time market feeds. This ensures that your algorithms get better access to data to identify market changes and take action, without much lag.

3. Enhanced Strategy Performance:
The performance of your strategy depends on latency and data access. With co-location servers, your strategies are the first to act and ensure your trades hit the market at the right moment.

Can Retail Traders Get Access to Co-Location Servers?

Retail traders typically cannot get direct access to co-location servers. These servers are primarily designed for high-frequency traders (HFTs) and institutional investors who require extremely low latency for their trading activities. The cost of renting server space is very high, some costing ₹15 lakhs a month, making it unaffordable for most retail traders.

However, retail traders can use broker/trading platforms like Zerodha and Upstox, and authorised data vendors like TrueData, Global Datafeeds, and Accelpix to source near real-time data access for algo trading. While these platforms may still need to fully utilise the speed advantages of co-location, they allow retail traders to compete in the stock market.

What are the Costs and Risks of Co-Location Servers?

1. Significant Expenses: Renting space in an Indian co-location centre will cost around ₹5 lakhs to ₹15 lakhs per month. This price includes power, cooling, and high-speed connectivity charges. These costs for co-location will be a huge financial commitment for small traders or firms with a minimal budget.

2. Tech Maintenance: Maintaining co-located servers requires a technically skilled team. You need experts to keep everything running smoothly. Any downtime or technical issues can lead to significant losses, so having a reliable support team is crucial.

3. Security Concerns: Storing your trading algorithms in a third-party data centre brings about security risks. Breaches or unauthorised access can expose your strategies, leading to financial and reputational damage. Keeping your systems secure is a top priority.

4. Regulatory Analysis: Co-location servers work under tight scrutiny due to fairness-related concerns. Traders must comply with several tight regulatory rules to continue co-location service usage. Regular reviews are made by authorities concerning data access, system performance, and trading behaviour for transparency. In cases of non-compliance, heavy fines, restrictions, or a ban from trading are imposed.

Conclusion

Co-location servers help reduce latency and improve access to real-time data, providing an edge in trading. This technology is mostly utilised by high-frequency traders and large institutions to execute trades efficiently. While it enhances speed and data access, it comes at a very high cost and risk.

For retail traders, the costs and complexities of co-location servers make them less accessible. While you may not be able to fully leverage this technology, you can still succeed by focusing on strong trading strategies, risk management, and alternative tools to stay competitive!

What is Co-location?

Generally, brokers and proprietary traders have machines at their offices which are connected to a primary server at the National Stock Exchange through which they place orders. Sometimes, because of too many people trading on this server and technical glitches, there was a delay in placing orders which caused losses to these brokers and proprietary trading firms.

The National Stock Exchange, in the year 2009, started providing ‘co-location services’ to brokers for a fee. In this, brokers and firms were allowed to place their servers within the premises on the National Stock Exchange for a premium. This provided them tick-by-tick price data, faster than others and hence giving an advantage over them. A tick by tick data is the most detailed data available showing each and every trade, every second, that is made on the exchange.

Even though this was a question of a few seconds, this led to huge amounts of profits for the firms that availed of the co-location services. Most of these firms used algorithmic trading or high-frequency trading (HFT), where machines and computers buy and sell shares within a matter of seconds based on algorithms. A faster price feed caused them to profit almost every day out of this.

Co-location services are completely legal and NSE had done nothing wrong in offering these services. However, the Securities and Exchanges Board of India (SEBI) had decided to turn a blind eye to the regulation of this service. SEBI did not launch any ‘working paper’ or strict guidelines regarding these services. Some say that there was a political nexus behind this motive.

The Co-location Scam

Secondary Server: There are two kinds of servers at NSE that process all the trades, primary servers and backup secondary servers. In co-location, broker’s servers were connected with a primary server and in case of a technical snag, they were connected with the backup servers.

Preferential Treatment: Some brokerages tied up with the employees of the National Stock Exchange (NSE) in order to know which secondary server would be switched on and when. These brokers would therefore be the first ones to connect to the secondary server and would later populate the server by connecting more than twice. This would cause the server to act slowly for other brokers due to increased traffic, giving an advantage to them. Mainly, one firm called OPG Securities is said to have taken advantage of the above-given situation. Many brokers were given preferential connections to the servers of NSE. It is said that the senior management of NSE plus some politicians had their personal interests in these firms.

A company named AlphaGrep with the help of a company named Sampark Infotainment set up ‘dark-fiber’ links connecting the NSE servers with its own. A dark-fiber is an unused optical fiber. There is no traffic or disturbance on the dark fiber, which means that AlphaGrep could get the tick-by-tick data faster than others. This was done with irregularities. The company, Sampark Infotainment did not have the necessary licenses from the Department of Telecommunications.

How the Scam Got Public

A whistleblower by the name of ‘Ken Fong’ from Singapore wrote to SEBI in 2015 regarding irregularities in the co-location system in NSE and the use of dark fiber lines. As time passed, the whistleblower wrote more such letters to SEBI and business-media houses. Sucheta Dalal who exposed the Harshad Mehta scam published the first letter on her website MoneyLife, you can check it out here.

Fun Fact: NSE filed a Rs 100 crore defamation suit against MoneyLife for the article regarding the co-location scam, but itself ended up paying 3 Lakhs to MoneyLife in restitution. They were also fined another Rs 47 lakhs to be paid to Tata Memorial Hospital and Masina Hospital in Mumbai.

SEBI formed an Expert Committee (EC) for the preliminary investigation of the claims. The Technical Advisory Committee (TAC) of SEBI investigated the technical matters of the claim. Ironically, the NSE formed a Disciplinary Action Committee(DAC) to act against brokers who were involved in the scam.

Deloitte, Ernst and Young, and the Indian School of Business were appointed to perform a forensic audit of the scam. The Income Tax Department and CBI probed the co-location ‘scam’.

In December 2016, NSE’s then CEO Ms. Chitra Ramakrishna and Vice Chairman, Ravi Narain, resigned. The National Stock Exchange’s IPO was stalled and still has not happened. The NSE was ordered to pay close to Rs 1,300 crores in fines which it tried to recover by fining other brokers and firms involved in the co-location scam.

The Current Situation

In January of this year, regulatory body SEBI dropped charges on nine current and former officials of the exchange, including ex-MD and CEO Ravi Narain, saying they cannot be held responsible for any misconduct or non-compliance in the so-called ‘dark-fibre issue’. Then who can be held responsible?

What happens when the people and institutions who are supposed to protect us turn villains? Are these fines enough to stop or scare them? Is this not comparable to cheating retail consumers? And why was no one sent to jail even after clearly profiteering and getting caught? A lot of questions remain unanswered. NSE is even saying that it has ‘strong grounds to contest the above orders including monetary liability raised by SEBI’.

Would certainly love to get more clarity on who actually are involved, with the top courts of the country taking strict action against officials trying to loot us.

You can read more about the co-location scam in the official SEBI order over here.