In high-frequency trading (HFT), every microsecond counts. Traders rely on ultra-fast execution speeds to capitalize on tiny market inefficiencies, often competing against firms operating near-lightning speeds. And what’s the key to competitive advantage among these firms? Low latency.
This piece explores how to achieve low latency for high-frequency trading. Whether you’re a trader, investor, or tech enthusiast, understanding the mechanics of low-latency trading sheds light on how modern financial markets operate.
Understanding Low Latency and High-Frequency Trading
Before we describe how to achieve low-latency high-frequency trading, let’s be sure we understand the terms.
What is Low Latency in Trading?
Latency in trading is the delay between when you create an order and when that order gets executed. Latency can be high or low, but you obviously want to keep yours as low as possible. For instance, a half-second delay in the execution of your order during a volatile market movement could mean the difference between getting slipped or just escaping. So, what exactly is low-latency trading?
Low-latency trading refers to the execution of trades with minimal delay. It involves executing orders in milliseconds and microseconds from creation. Reducing latency is crucial for traders, especially those involved in high-frequency trading (HFT), because even milliseconds can mean the difference between making a profit or missing an opportunity.
Market data latency is another important aspect of latency in trading. It’s the time it takes for market data to go from exchange servers and broker servers to market participants.
Institutions and hedge funds invest heavily in ultra-fast trading infrastructure to ensure they can react to market changes faster than competitors.
Talking about High Frequency Trading, let’s shed a little more light on it.
What is High-Frequency Trading?
High-frequency trading (HFT) is a specialized form of algorithmic trading that involves executing large numbers of trades at extremely high speeds. HFT firms leverage powerful computers, sophisticated algorithms, and ultra-low latency networks to capitalize on short-lived market inefficiencies.
Imagine an HFT firm monitoring Tesla’s stock price across different exchanges. On Exchange A, Apple’s stock is momentarily priced at $150.00, while on Exchange B, it’s $150.02. The firm’s algorithm instantly buys the stock on Exchange A and sells it on Exchange B, profiting from the $0.02 price difference. This entire process happens in microseconds, long before a human trader could react.
HFT is often used for strategies like market making, statistical arbitrage, and latency arbitrage, where speed is the defining factor between success and failure.
What is the Impact of Latency on High-Frequency Trading?
HFT firms operate on razor-thin margins, profiting from price discrepancies that exist for just milliseconds. Now, imagine a so-called HFT firm whose latency is as high as a hundredth of a second. To the human mind, that’s still quick enough. But to the HFT, it’s a bloodbath for their capital.
In addition to the speed advantage that low latency affords HFT, reduced slippage is another huge benefit. When orders are filled at the intended price, High-frequency trading firms can avoid incurring losses due to unfavorable price changes.
Another significant impact of latency on High-Frequency Trading is the quality and quantity of strategies that can be used. The lower the latency, the more leeway the HFT firm has to make bigger profits, adjust strategies and risk management techniques, and even develop new strategies.
In essence, low latency is the backbone of high-frequency trading, allowing firms to execute massive trade volumes profitably. Without ultra-fast execution speeds, HFT strategies would lose their competitive edge, making latency optimization a top priority for traders in this space.
How to Achieve Low Latency in High-Frequency Trading
HFT firms leverage a combination of cutting-edge technology, advanced infrastructure, and optimized trading strategies to reduce latency. Let’s see some of these methods:
1. Co-location
One of the most effective ways to reduce latency is co-location, which involves placing trading servers in the same data center as the stock exchange’s matching engine. This minimizes the physical distance trade orders must travel, reducing transmission time to a few microseconds.
For instance, a hedge fund trading on the New York Stock Exchange (NYSE) co-locates its servers within the NYSE’s data center in Mahwah, New Jersey. This allows their trade orders to reach the exchange in under 1 millisecond, whereas a retail trader executing the same trade from another location may experience latencies of 10-100 milliseconds.
In fact, it is so common that exchanges sell co-located server access to firms. Of course, it costs a pretty penny.
2. Server Leasing
One of the most common problems with co-location is that it can be pretty expensive to set up. And that makes server leasing an attractive idea. It pretty much works the same way co-location works, except that the HFT firm leases a server that already belongs to another establishment in the same data center that hosts the exchange’s server.
The upfront cost is way lower than owning your own server in the same data center as the exchange. It also allows you to grow into High-Frequency Trading with minimal upfront investment.
3. High-Speed Infrastructure
HFT firms invest heavily in ultra-fast networking technology to ensure minimal delays in data transmission. Some of the key network enhancements include:
- Network Infrastructure Optimization: This involves improving the efficiency of the pathway of a trading order between the HFT firm’s system and the exchange’s server. There are many processes involved in achieving this, such as Direct Market Access and Smart Order Routing.
- Hardware Infrastructure Optimization: We believe the hardware of the HFT firm is where latency begins. That’s why these firms invest massively in the latest and fastest computer technology, including GPUs, RAMs, network cards, and more. If a piece of tech is shaving milliseconds off latency, you can best believe an HFT firm is getting it.
- Software Infrastructure Optimization: Inefficiencies in software code can also increase latency. This applies to all kinds of software, including the Operating System and the trading platform itself.
We have a piece on how to build a low-latency trading infrastructure, in which we detail how HFTs and every other firm that needs low latency can achieve it.
Over to You
In high-frequency trading (HFT), speed is everything. The ability to execute trades in microseconds gives firms a competitive edge, enabling them to capitalize on market inefficiencies. As a result, achieving low latency is not an option. It’s a necessity.
Frequently Asked Questions
These are answers to some of the most common questions about achieving low latency for high-frequency trading.
What’s the best latency for high-frequency trading?
The best latency for high-frequency trading (HFT) is typically measured in microseconds (µs) or even nanoseconds (ns). The lower the latency, the better the execution speed.
What techniques do high-frequency trading systems use to minimize latency?
Co-located Server Leasing, Direct Market Access, and investments in high-speed infrastructure are some of the techniques high-frequency trading systems use to minimize latency. While zero latency is not yet possible, HFT firms can get close enough to it to trade profitably.
How fast do high-frequency traders trade?
High-frequency traders execute their trades in microseconds. They use powerful techniques, such as co-located server leasing and high-speed infrastructure, to achieve this ultra-low latency.
