Since this book is primarily designed to introduce what modern algorithmic trading looks like, we will focus on trying to understand how a modern electronic trading exchange appears. Gone are the days of people yelling at one another in the trading pits and making hand signals to convey their intentions to buy and sell products at certain prices. These remain amusing ideas for movies, but modern trading looks significantly different.
Today, most of the trading is done electronically through different software applications. Market data feed handlers process and understand market data disseminated by the trading exchanges to reflect the true state of the limit book and market prices (bids and offers). The market data is published in a specific market data protocol previously agreed upon by the exchange and the market participants (FIX/FAST, ITCH, and HSVF). Then, the same software applications can relay that information back to humans or make decisions themselves algorithmically. Those decisions are then again communicated to the exchange by a similar software application (order entry gateways) that informs the exchange of our interest in a specific product and our interest in buying or selling that product at specific prices by sending specific order types (GTDs, GTCs, IOCs, and so on). This involves understanding and communicating with the exchange in an exchange order entry protocol previously agreed upon by the exchange and participants at the exchange (FIX, OMEX, OUCH).
After a match takes place against available market participants, that match is conveyed back to the software application again via the order entry gateways and relayed back to the trading algorithm or the humans, thereby completing a transaction, often wholly electronically. The speed of this round trip varies a lot based on the market, the participant, and the algorithms themselves. This can be as low as under 10 microseconds all the way up to seconds, but we will discuss this in greater detail later.
The following diagram is a descriptive view of the flow of information from an electronic trading exchange to the market participants involved, and the flow of information back to the exchange:
As shown in the preceding diagram, the trading exchange maintains a book of client buy orders (bids) and client ask orders (asks), and publishes market data using market data protocols to provide the state of the book to all market participants. Market data feed handlers on the client side decode the incoming market data feed and build a limit order book on their side to reflect the state of the order book as the exchange sees it. This is then propagated through the client's trading algorithm and then goes through the order entry gateway to generate an outgoing order flow. The outgoing order flow is communicated to the exchange via order entry protocols. This, in turn, will generate further market data flow, and so the trading information cycle continues.