It is often said that success is 1% inspiration and 99%
perspiration. The business of
High Frequency Trading
(HFT) in the global forex markets fits that adage. In many
cases, HFT also referred to as
algorithmic trading
, aims to earn small, short-term profits on a high number of
trades. One must devise a trading strategy and develop and
maintain a complex, algorithmic system to constantly look for
profitable opportunities. Institutional Forex trading has
only recently embraced HFT in the past 5-6 years.
In order to execute a prescribed strategy in a systematic
manner, the principal trading entity (the trader) must first
conceive and deliver a viable trading strategy that is then
rendered as a machine-readable algorithm. Once back-tested
and benchmarked for statistical probability of success, a
principal must engage the requisite liquidity source or sources,
establish credit arrangements with counterparties, procure the
hardware to house the execution and risk-management environment
and optimize the technical infrastructure such as software and
operating systems.
Institutional level HFT is rarely conducted over the public
internet, due to latency issues and is generally outsourced to an
institutional-grade data center. Due to the extreme
necessity for speed in the execution of trades, most principals
seek to co-locate their transaction servers at distances measured
within meters of their liquidity provider's servers.
Milliseconds can mean the difference between success and failure
in High Frequency Trading.
Seeking Alpha within Low-Cost Transaction
Environments
The global spot currency market is ideally suited for High
Frequency Trading because of the low transaction costs associated
with the asset class and the deep liquidity offered in the global
forex markets, which are estimated to be approximately $5
trillion per day according to the Bank for International
Settlements (
BIS
). Over-the-counter spot forex trading does not carry the
costs-such as ticket fees-- usually associated with
exchange-traded instruments as in the futures and securities
markets. The principal trader incurs transaction costs
through the bid/ask spread, and it becomes imperative to seek the
lowest possible spreads available. Generally speaking,
there is direct correlation between spread size, trade size and
monthly-transacted volumes. The greater the deal size and
monthly volume, the lower or narrower the spreads are likely to
be.
Ideally, the principal should seek a liquidity provider that
offers the lowest institutional spreads, or near what is referred
to as "choice." A "
choice spread
" offers dealing at the same rate for bid and ask (no
spread). In most cases choice spreads carry a fee based on
volume transacted. Fee-based models can be as much as $20
per million dollars transacted but are in most cases
negotiable. One of the benefits of a choice spread
for the principal trader is a fixed cost structure. That is
of course assuming the spread is consistently lower...or similar
to that of non-fee-based arrangements.
In almost all arrangements, spreads are not fixed and
will vary based on market conditions. It is therefore
necessary to manually monitor your liquidity price feed over an
extended period to observe fluctuations, anomalies or other
non-standard biases in price behavior. Fee-based
arrangements will often require the trader to maintain a small
balance in a cash account for the weekly payment of transaction
fees.
Fee-based arrangements have additional benefits in many cases
as they also cover the cost of credit. Seek to find a
liquidity provider that can provide multiple services under one
fee umbrella; this is usually the most cost-effective
solution. There are several firms who offer multiple
services. One such firm is New York-based
IBTRADE
.
On the credit side, the counterparty or liquidity provider
chosen by the trader should be able to provide credit directly or
through a prime-brokerage account or other credit and swap
agreements such as give-ups. Naturally, due diligence
should be exercised and credit worthiness should be vetted
through the appropriate channels.
Single-Source, Fully Disclosed Bank Feed vs. Anonymous,
Multibank Feed
The trader should seek to access multiple liquidity sources to
take advantage of any
forex arbitrage
opportunities and to ensure the deepest and most consistent pool
of liquidity is available. Trading via a single liquidity
source exposes the trader to possible lapses in liquidity and
adaptive biases by the liquidity provider, whereby the single
source provider has full transparency into the trader's activity
and may occasionally or frequently adjust spreads in a subjective
manner.
The trader could integrate multiple bank or other liquidity
providers and diversify their liquidity pool. This is a
complex, time-consuming and expensive proposition.
Companies such as IBTRADE offer a consolidated liquidity solution
for a price and execution feed from 10 of the world's largest
banks and liquidity providers as a fully integrated, multi-bank
feed with complete trading anonymity.