Arbitrage trading has long been considered the Holy Grail of Forex trading and for good reason. When it works, it can produce some pretty explosive results. But such fantastic results are no longer something you an achieve with your eyes closed.
The Forex industry has changed significantly in the last 12 months. In 2016 alone, some very important changes have occurred in the industry that are not fully understood by the trading community. In this article, I will attempt to outline these changes, their impact on forex arbitrage trading strategies, practical steps to regain control and get those explosive results back.
The scope of this article is limited to discussing the most promising of all arbitrage trading strategies – 1-Leg Latency Arbitrage.
For those unfamiliar with this strategy, Latency arbitrage relies on pricing inefficiencies between two brokers. You check the price of the “fast broker” and anticipate where the price is going to move and place an order accordingly on the “slow broker”. You can find a more detailed explanation of this strategy in our previous article about how to choose the right broker for latency arbitrage strategy.
Latency arbitrage is a complex strategy in the inner workings of it. It looks simple enough on the outside but under the hood, there’s a lot going on to make all the moving parts work in unison to generate the right results.
In its most basic form, Latency Arbitrage strategy has 2 aspects to it. The Fast Leg and the Slow Leg.
You need to have a good price feed. Fast. Reliable. With zero latency. This is where you need to read prices off of. If this feed is lagging, you’re not going to get anywhere with your strategy. it begins with the quality of the fast feed. Typically, the most used fast feeds in the industry are LMAX, SAXO BANK, Rithmic and CQG.
LMAX and Saxo are primary based out of UK (LD4 to be exact) while CQG and Rithmic are based out of the US (Chicago to be exact). Rithmic supposedly has a relay in UK too but I’ve never used it so cannot comment on its quality or capabilities.
LD4, which is the London Datacenter of Equinix, where all the big banks are, is heavily crowded. Almost all the brokers flock to that venue and so do all the traders. But what these traders don’t know is that 99% of the brokers housed in LD4 are not STP brokers. They are all B-Book, dealing desk brokers. They are great for Latency Arbitrage because they’re a classic bucket shop broker with inefficiencies built in every aspect of their businesses. However, the fact that they B-Book all your trades also means that your success on these brokers is limited – 100% guaranteed…. Once you win too much, they will either stop you, block you or rob you of your profits.
NY4, which is the New York location of the Equinix Data Centre is where the real action is these days. a few STP brokers including Manhattan Global Markets are based in NY4. Manhattan, specifically has very deep liquidity, which means your latency arbitrage strategies have the best possible chance of working at MGM than anywhere else.
But, until recently, there was a major challenge for all traders attempting Latency Arbitrage out of NY4. The fast feed. Both Rithmic and CQG provide a fast feed but because they are both based out of Chicago, the quickest they can deliver the prices to you is 16ms at best and 69ms at worst. That’s too slow.
So Manhattan Global Markets decided to put up their own fast feed out of NY4 with 0ms latency to all NY4 venues. You can read more about our Fast Feed for Latency Arbitrage and see why its a major leap forward for enabling Latency Arbitrage traders in 2017.
Now that we have understood the elements involving the “fast side”, lets talk a little bit about what goes on in the slow side. Many traders that have attempted Latency Arbitrage have been educated by the vendors of such software to look for “instant execution”. Let me tell you point blank: Instant Execution does not exist, except in the case of B-Book brokers. You see, this is how execution works in the world of Forex – especially though Mt4.
When you, the trader, places a trade, a B-Book broker does not send it to the liquidity provider but simply accepts it by taking the other side of your trade. If you’re going long on EURUSD 1 Lot, he is taking the short on the other side. He can do this instantly with 0ms delay because there’s no communication to be had with anyone outside the server (e.g liquidity provider).
Now on the other hand, if you’re dealing with an honest, STP broker, the trade goes directly to the liquidity provider where it could be met with several execution challenges (which I will discuss shortly) before your trade is executed. MT4, by default, has a 50ms delay for any repetitive communication between MT4 servers and the FIX API bridge over which such trades are usually executed. The fastest STP execution of a trade out of MT4 cannot be less than 80ms even under the best network conditions. However, Latency Arbitrage works with up to 200ms delay so there’s no need for you to jump from broker to broker, looking for instant execution because all you’re doing is setting yourself up for a fall sooner or later with broker manipulation which is imminent with B-Book brokers.
Latency arbitrage strategy thrives on volatility and sharp market movements. Unfortunately, its at those times that banks (liquidity providers) are most wary of filling trades that will result in a loss for them. Having said that, during those times, spreads also increase due to natural market elements thereby causing prices to move faster than you can place a trade thereby leading to slippage. Any broker that tells you that they don’t have slippages are trying to tell you the equivalent of “when it rains, my roof doesn’t get wet…” – impossible.
Furthermore, liquidity is not the same throughout the day and for every instrument. The 4 fast feeds mentioned above have limited symbols available for price quotes makes your choice of tradable instruments limited to just about a dozen.
Banks have algorithms that are capable of detecting (somewhat) the type of strategy you are using to trade against them. 99% of brokers aren’t immune to them unless the brokerage has been purpose built to support high frequency traders through a deep liquidity pool and anonymization of trades.
I’m sure if you have arrived at this page then you’ve either already researched Latency Arbitrage Software or are aware of the options in the market – especially those being sold by engineers from the North Eastern part of our beautiful planet. We have experimented with every single software option available in the market and we found the exact same deficiency in every single one of them.
All those products are designed to work in a “perfect world” scenario where the fast leg and the slow leg are so harmoniously fine tuned with each other that you cannot lose a single trade. Unfortunately, such scenarios don’t exist anymore.
One software is good with trailing, the other lacks in identifying an exit gap. One does a good job of recognizing arbitrage opportunities but lacks in having reliable fast feed connections. So, in short, the options are very limited and require a lot of fine tuning and adjustments.
Oh and by the way… if you test any of these software on demo accounts it will simply blow your mind. Live accounts – different story altogether.
Drop me an emailif you are looking for some test insights into these software. I’d be happy to assist.
VPS and Network Latency
Not all VPS’ are created equal. The fact that a VPS claims to be in the equinix data centre with low latency network infrastructure does not mean that it will generate good results for this type of strategy. We’ve discovered that a good VPS is a critical moving part in this strategy that needs to be fine tuned too. CPU usage, RAM consumption, network latency, packet loss… all these are important factors to monitor and improve according to your broker and your EA.
Practical Steps for achieving success with latency arbitrage in 2017
- Get a good Fast Feed – Look, trying to make this strategy work in an already crowded market (LD4) is a lot of futile work. You’re better off tapping into NY4 where the liquidity is deep and the opportunities are considerably better.
- Get a trusted partner for your slow leg – Take a look at this article for more on this
- Try to get away from MT4. work with a FIX API Broker and get a low deposit FIX API account with them.
- Get a good EA – Email me. I can help you find the right one. No I’m not an affiliate with anyone and I don’t care if you win or lose. I’m simply happy to pass on what I’ve learnt so I can help someone else cut short the learning curve – KARMA people…..KARMA… !
- Get a good VPS – Beeks….no. FXVM….no. UltraFX – don’t have NY4 (yet)…Chocoping…mixed results. You’ve just got to try out a few options… but you need to look for a dual core, 10GBPS network connected VPS with at least 2GB of RAM.
Feedback, questions and comments are welcome…